Unencumbered Definition Explained Examples Vs Encumbered

Unencumbered Definition

Unencumbered refers to any asset that is not subject to creditors’ claims. For instance, securities purchased with cash rather than on margin and mortgage-free homes. It is useful to determine the status of an asset to sell it as an unencumbered one that can be transferred easily.

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Before buying any asset or property, it is important to ensure that it is unencumbered, meaning free from any obligations to creditors, implying the owner completely owns it rather than having any pending settlements. This term can be extended across property, assets, securities, and cash, where the context remains the same.

Key Takeaways

When there are no liens or other claims against an asset, we call it “unencumbered.” It is the opposite of encumbered, where an asset is susceptible to any legal claim, like a security for a loanIt is simple to sell or transfer ownership of the unencumbered item because the existing owner has complete control over it, and no due amount is pending before selling the asset.Debentures have a general claim on the issuer’s assets and earnings but no encumbrances, meaning that any property or collateral does not secure them.

Unencumbered Explained

Unencumbered are those assets that are free of any borrowed money, liens, or claims. In contrast, if a property is encumbered, it is subject to a financial burden or loan. An asset may be encumbered if it is prone to any legal claim, such as when it is pledged as security for a loan, when it is the subject of a pending legal action, or when a tax claim, judgment lien, or mechanic’s lien, has been filed against it. Without liens or claims, an asset is more likely to attract buyers and ease a smooth transfer.

Most people probably don’t own completely free and clear versions of their most valuable possessions, such as houses or cars. The high frequency with which such acquisitions are funded results in getting debt using the item as security. After paying the debt like unencumbered mortgages and auto loans, the owner regains full legal title to the property they once secured.

Debentures have a general claim on the issuer’s assets and earnings but no encumbrances, meaning that any property or collateral does not secure them. Therefore, in the event of liquidation of the issuer, the investors of the debenture bonds would be entitled to all of the assets that have not been pledged to satisfy other debt. So, having some assets that aren’t currently tied down to debt can assist mitigate financial stress later on.

As they may still issue bonds at cheap interest rates even without collateral, highly trusted companies often choose not to do so. That’s why debentures, which are unsecured and not backed by any collateral, can fetch a higher price than bonds having encumbrances issued by less dependable issuers.

Examples

Let us look at the example of unencumbered to understand the concept better:

Example #1

Sam is a young working professional who a major textile company currently employs. He saw an opportunity to buy a small apartment in the city with two bedrooms. He took his chance by using his funds and getting a loan from the bank. However, soon enough, there was a significant increase in the estate’s value, and Sam desired to take advantage of this.

However, the encumbered land made it difficult for him to sell it. Finally, he decided to approach his mother with the remaining loan balance to release the land from the debt. After making the payment to the bank, he had a property free of any encumbrances and could easily sell it.

Example #2

An article by Mondaq explains how unencumbered assets are sometimes made encumbered knowingly by the owner to avoid their transfer or sale during liquidation. However, legally it is implied that insolvent debtors can’t sell or transfer assets. Therefore, disposing of one’s final asset when nearing potential bankruptcy is a sign of deception. Still, it produces a larger presumption of deceit when the transfer is of an unencumbered asset.

In a ruling by a court, a debtor was allowed to sell commercial estate on the eve of insolvency. Moreover, one of its creditors was left with no remedy. Likewise, an asset is often heavily burdened and transferred to satisfy the encumbrances. In such a case, proving that the transfer was against the law or fraudulent is difficult.

Unencumbered vs Encumbered

Unencumbered securities that are burdened in some way contrast with those that are not. For instance, a third party’s claim on a piece of property is known as an encumbrance. An encumbrance may impair the property’s transferability and freedom of use until clearance of the hindrance.

An unencumbered property or item is free and clear of any claims, liens, or judgments. In addition, selling or transferring the item title is easy because the owner has complete control over it.

When there are liens or other claims against an asset, we call it “encumbered.” It can manifest in various ways, such as mechanic’s liens or court judgments. Before selling, the owner must remove the encumbrance. Therefore, a title search is necessary before selecting a home since encumbrances are common issues in real estate deals.