Secured Debt

Financial Dictionary -> Debt -> Secured Debt

A secured debt is a debt on which the lender has a lien. The lien is an item of value, usually a type of property that the debtor pledges as security to cover the outstanding balance on the loan. The creditor can take ownership of the pledged asset in case that the borrower defaults on his loan. Real estate property, personal property, equipment, or a combination of them can be used as security assets.

In real estate, the mortgage is a prime example of secured debt. The mortgage is a loan granted for the purchase of a home where the property becomes collateral if the borrower cannot repay the loan. If this occurs, the lender can organize a foreclosure or repossession. During foreclosures, the mortgaged property may be sold in order to pay the debt of the borrower. Repossession represents a process in which the property is taken by the creditors if the debtor fails to make payments on the loan.

In addition to the mortgage, which as voluntarily created lien, secured debt in real estate can take the form of a mechanics lien. The main condition for the creation of a mechanics lien is to enhance the property through materials or work provided by the person who files a mechanics lien. Another common type of secured debt is the car loan where the creditor can repossess the car if the borrower defaults on loan.

Since the lien against the loan reduces the financial risks for the creditors, the borrower receives the loan under much more favorable conditions (such as attractive interest rates and repayment periods in contrast to the unsecured loans).

In addition to paying less money, due to less financial charges and lower interest rates, the secured debt is attractive to the borrower of the nonrecourse loan: a secured loan where the collateral is the only security which the lender has, without further recourse against the borrower for any deficit after foreclosure of the property. This type of contract is called Purchase Money Security Interest (PMSI) loan, in which the creditor takes a security interest in the items purchased. For example, if a debtor uses a secured loan to purchase a car, even if he defaults on the loan, the lender cannon come after the debtor's other assets. Contractual agreements can also be secured by a Non-Purchase Money Security Interest (NPMSI) loan, in which the crediting body takes interest in items already owned by the borrower.

In addition to the consent of the parties as result of a contractual agreement, debt can become secured by the virtue of statute, or by judicial process. Secured debt consolidation loans are used to channel all debts of a borrower into a single loan and are granted against a security or collateral provided by the borrower.