Secured loan
Encyclopedia
A secured loan is a loan
in which the borrower pledges some asset (e.g. a car or property) as collateral
for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral — in the event that the borrower defaults
, the creditor takes possession of the asset used as collateral and may sell it to regain some or all of the amount originally lent to the borrower, for example, foreclosure
of a home. From the creditor's perspective this is a category of debt
in which a lender has been granted a portion of the bundle of rights
to specified property. If the sale of the collateral does not raise enough money to pay off the debt, the creditor can often obtain a deficiency judgment
against the borrower for the remaining amount. The opposite of secured debt/loan is unsecured debt
, which is not connected to any specific piece of property and instead the creditor may only satisfy the debt against the borrower rather than the borrower's collateral and the borrower.
to take the property in the event that the debt is not properly repaid. In exchange, this permits the second purpose where the debtor
s may receive loan
s on more favorable terms than that available for unsecured debt
, or to be extended credit
under circumstances when credit
under terms of unsecured debt
would not be extended at all. The creditor may offer a loan with attractive interest rates and repayment periods for the secured debt.
, the most common form of secured debt is the lien
. Liens may either be voluntarily created, as with a mortgage, or involuntarily created, such as a mechanics lien
. A mortgage may only be created with the express consent of the title owner, without regard to other facts of the situation. In contrast, the primary condition required to create a mechanics lien
is that real estate
is somehow improved through the work
or material
s provided by the person filing a mechanics lien
. Although the rules are complex, consent of the title owner to the mechanics lien
itself is not required.
In the case of personal property
, the most common procedure for securing the debt
is described through the Uniform Commercial Code
or UCC. This statute
provides a system of forms and public filing of documents by which the creditor
's interest in the property
is made known.
In the event that the underlying debt
is not properly paid, the creditor
may decide to foreclose the interest in order to take the property
. Generally, the law that allows the secured debt to be made also provides a procedure whereby the property will be sold at public auction
, or through some other means of sale. The law commonly also provides a right of redemption
, whereby a debtor may arrange for late payment of the debt
but keep the property.
(PMSI) loan, where the creditor takes a security interest in the items purchased (i.e. vehicle, furniture, electronics); or, a Non-Purchase Money Security Interest (NPMSI) loan, where the creditor takes a security interest in items that the debtor already owns.
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
in which the borrower pledges some asset (e.g. a car or property) as collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral — in the event that the borrower defaults
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
, the creditor takes possession of the asset used as collateral and may sell it to regain some or all of the amount originally lent to the borrower, for example, foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
of a home. From the creditor's perspective this is a category of debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
in which a lender has been granted a portion of the bundle of rights
Bundle of Rights
The bundle of rights is a common way to explain the complexities of property ownership. Teachers often use this concept as a way to organize confusing and sometimes contradictory data about real estate....
to specified property. If the sale of the collateral does not raise enough money to pay off the debt, the creditor can often obtain a deficiency judgment
Deficiency judgment
A deficiency judgment is an unsecured money judgment against a borrower whose mortgage foreclosure sale did not produce sufficient funds to pay the underlying promissory note, or loan, in full. The availability of a deficiency judgment depends on whether the lender has a recourse or nonrecourse...
against the borrower for the remaining amount. The opposite of secured debt/loan is unsecured debt
Unsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment....
, which is not connected to any specific piece of property and instead the creditor may only satisfy the debt against the borrower rather than the borrower's collateral and the borrower.
Purpose
There are two purposes for a loan secured by debt. In the first purpose, by extending the loan through securing the debt, the creditor is relieved of most of the financial risks involved because it allows the creditorCreditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
to take the property in the event that the debt is not properly repaid. In exchange, this permits the second purpose where the debtor
Debtor
A debtor is an entity that owes a debt to someone else. The entity may be an individual, a firm, a government, a company or other legal person. The counterparty is called a creditor...
s may receive loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
s on more favorable terms than that available for unsecured debt
Unsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment....
, or to be extended credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
under circumstances when credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
under terms of unsecured debt
Unsecured debt
In finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment....
would not be extended at all. The creditor may offer a loan with attractive interest rates and repayment periods for the secured debt.
Types
- A mortgage loanMortgage loanA mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
is a secured loan in which the collateral is property, such as a home. - A nonrecourse loanNonrecourse debtNon-recourse debt or a non-recourse loan is a secured loan that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the...
is a secured loan where the collateral is the only security or claim the creditor has against the borrower, and the creditor has no further recourse against the borrower for any deficiency remaining after foreclosure against the property. - A foreclosureForeclosureForeclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
is a legal process in which mortgaged property is sold to pay the debt of the defaulting borrower. - A repossessionRepossessionRepossession is generally used to refer to a financial institution taking back an object that was either used as collateral or rented or leased in a transaction. Repossession is a "self-help" type of action in which the party having right of ownership of the property in question takes the property...
is a process in which property, such as a car, is taken back by the creditor when the borrower does not make payments due on the property. Depending on the jurisdiction, it may or may not require a court order.
United States law of debt secured by property
In the case of real estateReal estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
, the most common form of secured debt is the lien
Lien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
. Liens may either be voluntarily created, as with a mortgage, or involuntarily created, such as a mechanics lien
Mechanics lien
A mechanic's lien is a security interest in the title to property for the benefit of those who have supplied labor or materials that improve the property. The lien exists for both real property and personal property. In the realm of real property, it is called by various names, including,...
. A mortgage may only be created with the express consent of the title owner, without regard to other facts of the situation. In contrast, the primary condition required to create a mechanics lien
Mechanics lien
A mechanic's lien is a security interest in the title to property for the benefit of those who have supplied labor or materials that improve the property. The lien exists for both real property and personal property. In the realm of real property, it is called by various names, including,...
is that real estate
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
is somehow improved through the work
Manual labour
Manual labour , manual or manual work is physical work done by people, most especially in contrast to that done by machines, and also to that done by working animals...
or material
Material
Material is anything made of matter, constituted of one or more substances. Wood, cement, hydrogen, air and water are all examples of materials. Sometimes the term "material" is used more narrowly to refer to substances or components with certain physical properties that are used as inputs to...
s provided by the person filing a mechanics lien
Mechanics lien
A mechanic's lien is a security interest in the title to property for the benefit of those who have supplied labor or materials that improve the property. The lien exists for both real property and personal property. In the realm of real property, it is called by various names, including,...
. Although the rules are complex, consent of the title owner to the mechanics lien
Mechanics lien
A mechanic's lien is a security interest in the title to property for the benefit of those who have supplied labor or materials that improve the property. The lien exists for both real property and personal property. In the realm of real property, it is called by various names, including,...
itself is not required.
In the case of personal property
Personal property
Personal property, roughly speaking, is private property that is moveable, as opposed to real property or real estate. In the common law systems personal property may also be called chattels or personalty. In the civil law systems personal property is often called movable property or movables - any...
, the most common procedure for securing the debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
is described through the Uniform Commercial Code
Uniform Commercial Code
The Uniform Commercial Code , first published in 1952, is one of a number of uniform acts that have been promulgated in conjunction with efforts to harmonize the law of sales and other commercial transactions in all 50 states within the United States of America.The goal of harmonizing state law is...
or UCC. This statute
Statute
A statute is a formal written enactment of a legislative authority that governs a state, city, or county. Typically, statutes command or prohibit something, or declare policy. The word is often used to distinguish law made by legislative bodies from case law, decided by courts, and regulations...
provides a system of forms and public filing of documents by which the creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
's interest in the property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
is made known.
In the event that the underlying debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
is not properly paid, the creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
may decide to foreclose the interest in order to take the property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
. Generally, the law that allows the secured debt to be made also provides a procedure whereby the property will be sold at public auction
Public auction
A public auction is an auction held on behalf of a government in which the property to be auctioned is either property owned by the government, or property which is sold under the authority of a court of law or a government agency with similar authority....
, or through some other means of sale. The law commonly also provides a right of redemption
Right of redemption
The right of redemption, in the law of real property, is the right of a debtor whose real property has been foreclosed upon and sold to reclaim that property if they are able to come up with the money to repay the amount of the debt. Most U.S. states have a statutory provision that allows such a...
, whereby a debtor may arrange for late payment of the debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
but keep the property.
How to create secured debt
Debt can become secured by a contractual agreement, statutory lien, or judgment lien. Contractual agreements can be secured by either a Purchase Money Security InterestSecurity interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
(PMSI) loan, where the creditor takes a security interest in the items purchased (i.e. vehicle, furniture, electronics); or, a Non-Purchase Money Security Interest (NPMSI) loan, where the creditor takes a security interest in items that the debtor already owns.
See also
- BankruptcyBankruptcyBankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
- Capital structureCapital structureIn finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80...
- Debt arbitration
- Loan guarantee
- Second lien loanSecond lien loanSecond lien loan is a form of loan with a security interest in the assets of a company that are second in ranking behind a traditional senior credit facility...
- Seniority (financial)Seniority (financial)In finance, seniority refers to the order of repayment in the event of bankruptcy.Senior debt must be repaid before subordinated debt is repaid...
- Senior debt
- Subordinated debtSubordinated debtIn finance, subordinated debt is debt which ranks after other debts should a company fall into receivership or bankruptcy....
- Title loan
- Unsecured debtUnsecured debtIn finance, unsecured debt refers to any type of debt or general obligation that is not collateralised by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment....