What are secured debts?

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A secured debt is any liability that is backed by collateral, either by the item financed or by some other asset with appraisable “fair market” value. With secured debts, the borrower essentially pledges or provides something of value in return for the receipt of a loan or object.

The opposite of secured debt is unsecured debt, in which no asset is used as security or collateral for the loan. Typical examples of unsecured debt include signature loans, cash advance loans and standard credit cards. For many borrowers, unsecured debt is usually always preferable. However, it is a necessity for many types of financing, especially large loan amounts.

The reason for collateral

The rationale behind debt security and collateral is risk.

All loans involve risk, especially for the lender. By requiring that the borrower put up some collateral for the provided loan, the lender is able to reduce some of the loan’s risk. Should the borrower default and not repay the loan based upon the original loan agreement, the secured loan provider would have the right to use the loan’s security to pay off any outstanding loan balances.

A common form of a secured debt is the automobile loan. When a lender makes an automobile loan, the borrower pledges the automobile as collateral. Should the loan go into default, the lender may repossess the automobile. Once the car loan is paid off, the lender will transfer the car title or pink slip to the borrower.

A mortgage loan is another common form of secured loans. A mortgage lender will place a lien on the property being financed, which records a legal interest in the property for the mortgage lender. If the borrower does not repay the loan or fulfill the obligations outlined in the promissory note and mortgage deed, the lender may file foreclosure proceedings to obtain full possession of the property and use it to pay off the mortgage loan balance.

As a lender seizes any pledged property the lender must follow all state and federal statutes that apply to asset seizures, as well as adhere to recovery procedures listed in the original loan agreement.

A secured debt borrower voluntarily agrees to pledge or provide the collateral asset as a condition for receiving the loan. If the lender requires specific types of collateral and the borrower refuses, then the lender will not make the loan.

Secured debts do not require the item financed to be all or part of the pledged asset. A lender can issue a loan to a borrower and record a legal interest in another appraisable asset. For example, a company is trying to obtain a $300,000 loan to upgrade its warehouse facility, but the current market value of the upgraded facility will be less than the loan amount. In order to push the loan through, the company can pledge other assets, such as some of the equipment or a separate parcel of vacant land it owns free and clear.

Should the borrower not repay the loan and go into default, the lender can seize the pledged asset. In addition to hard assets, lenders may also allow the borrower to pledge liquid assets, such as bank accounts, stocks or bonds or certificates of deposit.

Secured lending facilitates consumer finance and allows lenders to extend credit to those who may not otherwise qualify due to a lack of or a damaged credit history. One prominent example of this is the secured credit card, which allows individuals with less-than-perfect credit obtain a Visa or MasterCard credit account.

Secured debt has been a common fixture of personal lending since the rise of the first civilizations. Today, secured financing is an important feature of a functioning economy; and it allows companies and individuals obtain necessary financing to make important purchases, upgrades or investments. The main difference between secured lending of the past and today is that there are now various state and federal regulations providing additional protections – for both the borrower and the lender.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

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