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An encumbrance is some sort of restriction on property which can inhibit its transfer. Encumbrances can affect the title of property, or they may take the form of restrictions on funds. In both cases, the encumbrance restricts free use of the property or funds until the issue is resolved. Encumbrances take a number of forms.
One of the classic cases in which an encumbrance appears is in a real estate context. Some examples of encumbrances include liens on real estate, outstanding mortgages, easements, unpaid property taxes, or deed restrictions. All of these encumbrances are attached to the title of the real estate, and they can complicate or prohibit the transfer of the title until they are resolved. Encumbrances can also affect titles to other types of property, such as a car title.
In accounting, an encumbrance could be viewed as a type of funds hold. When an account has an encumbrance, it means that funds are being set aside to meet financial liability requirements. Although the funds are considered part of the account, they cannot be spent, because they are being held to discharge a bill. Once the bill is paid, the encumbrance is released and the funds are recorded as an expense. Colleges and universities may also use the term “encumbrance” to refer to a block on a student account which will not be lifted until the student gets current with payments.
Encumbrance accounting is used in a wide variety of settings. It can be confusing to people who are not familiar with it, because the status of funds may not be immediately clear. It can also be utilized to overinflate the contents of an account, by making it look like the account is filled with funds, when in fact the funds could be restricted and already designated for use elsewhere.
It is important to understand how an encumbrance will affect a transaction before committing to the transaction. For example, with real estate, people embarking on a short sale need to know that the bank has the final say in the purchase price of the property, because it holds a lien on the title and it will not release the lien unless it is satisfied. It is also important to research before making a purchase of an item which could be subject to an encumbrance, to confirm that there is no problem. For example, someone who buys a property with outstanding unpaid property taxes will inherit these expenses and the associated fees, and the tax agency could sell the property to recover them.