In real estate, free and clear refers to full and complete ownership of a piece of property. A home becomes free and clear often after paying off a home loan that gave a lender a claim to the property. However, additional assets (such as a car) can also become free and clear if the owner completely pays off the related loan.
If you’ve bought a home before, then you’ve probably run into some terminology used by your real estate agent or mortgage lender that you aren’t familiar with. One of those terms you might hear is “free and clear,” which is a slang phrase describing a type of ownership over a property. The phrase usually applies in the case of real property like homes, but can also apply to other assets like vehicles.
What does free and clear mean?
Free and clear describes an asset that someone owns outright without any liens or creditors who have a claim to it. The term is often used to describe an asset that was financed — such as a home or a car — and has now been fully paid off. At that time, the borrower gains outright ownership of said asset. You may also hear a free and clear asset referred to as “unencumbered.”
The most common use of the phrase free and clear is in real estate. It’s typically used to describe someone’s ownership status over their home. Most people use a mortgage to buy their homes, and as long as they owe money on the loan, the lender has a claim to their home. But when they own their home free and clear, it means there’s no outstanding loan and they own it outright.
The importance of a free and clear title in real estate
A free and clear title is so important in homeownership because if you don’t own the home free and clear, you’ll have a difficult time selling it. That’s not to say you can’t sell your home if you still have a mortgage. However, the proceeds from the home sale must go directly to the lender to pay off what’s still owed.
Additionally, if there are any other loans on the home, such as a home equity loan or HELOC, then they must also be paid off with the proceeds of the home. It’s not until all loans have been completely paid off that the seller can keep the rest of the funds.
Where a title that’s not free and clear becomes a problem is if there are liens on the home other than the mortgage. This could include a tax lien, a lien from a recorded judgment, or another claim to the property. These liens can prevent you from selling the home or, if you’re a buyer, prevent you from buying the home.
During the home closing process, there is a title search done by the title company to ensure there aren’t any liens on the home that would prevent the new owner (and the new owner’s lender) from taking legal ownership.
In many cases, someone might be buying a home while also selling a home with an outstanding mortgage. That situation becomes a bit more complicated and would require the person to make a contingent offer since they can likely only buy the new home if the sale of their old home is successful.
Other applications of free and clear
The phrase “free and clear” is most often used in reference to real estate. But it’s actually a broad term that can describe any situation where someone has total ownership of an asset, often after having paid off a loan.
For example, many people take out a secured loan when they purchase a car. The car serves as collateral for the loan, and as long as there’s a balance remaining, the lender has a claim to the car title. Once the borrower has fully repaid the car loan, they own the car free and clear.
In the case of buying a car, it’s important to make sure a seller owns it free and clear before you buy it. If someone has a lien on the title that gives a creditor claim to the vehicle, you’re likely to run into trouble with ownership down the line. Always make sure a seller can provide a clean title (and verify it before you hand over the money).
Pros and cons of free and clear ownership
Owning your property free and clear has plenty of benefits. That being said, there are also some downsides to owning a property free and clear, especially when it’s something as expensive as a home.
Here is a list of the benefits and drawbacks to consider.
- Peace of mind. First, there’s simply the peace of mind that comes with knowing you own something outright. You no longer owe money on your car or home, and the lender can’t take it away from you.
- No more interest. Owning your house free and clear also means you aren’t spending unnecessary money on interest each month. Interest rates on mortgages are generally low compared to other types of loans, but many homeowners still end up paying hundreds of thousands of dollars in interest on their homes. If you pay off your mortgage early, you can save money on some of that interest.
- Limited funds. When your money is tied up in your home, you may have cash flow and liquidity problems. Think about it this way: If your home is valued at $250,000 and you’ve paid it off, that’s $250,000 of your net worth that is untouchable unless you sell your home. If some of that money was in the bank, it could serve as an emergency fund or a way to finance other large purchases. Instead, by having your net worth tied up in your home, you limit your options.
- No ROI. Another downside to owning your home free and clear — at least if it involves paying off your mortgage early — is the return on investment you could have gotten with that money elsewhere. As we mentioned, mortgages have notoriously low interest rates. If you’re using your disposable income to make additional mortgage payments, you may only be getting a return of a few percent on your investment. But if you took that same money and invested it in the stock market, you could earn considerably more.
What does it mean to clear a mortgage?
When you clear a mortgage, it means you’ve fully paid it off. This means you have full and complete ownership of the home and your lender no longer has a claim to it.
Can a mortgage fall through after closing?
It’s possible for a mortgage to fall through right up until the time of closing. But once you’ve completed the closing, you officially have a mortgage.
Can a mortgage be denied after closing?
You can’t close on a home until the mortgage funds are available, meaning the mortgage has been fully approved. However, up until that time, the lender could theoretically still deny your application.
- Free and clear is when you have outright ownership of a property without any liens or secured loans.
- Free and clear most often applies to real estate, but can also be used in reference to a vehicle that’s been paid off.
- Ensuring a property is owned free and clear is essential before you buy or sell it.
- There are several advantages to owning your home free and clear, but there could also be some downsides.
View Article Sources
- Encumbered Assets – Montana Code Annotated 2021
- What is a Lien or Encumbrance? – Arizona Bar Foundation
- Buying a House with a Tax Lien? Here’s What You Need to Know – SuperMoney
- What is an Encumbrance? How it Works and FAQs – SuperMoney
- Lien vs. Encumbrance: Differences And Examples – SuperMoney
- What Does Pending Mean in Real Estate? – SuperMoney
- What is a Warranty Deed and Do You Need One? – SuperMoney
- Best Mortgage Lenders | June 2022 – SuperMoney