Secured Debt: Everything You Need to Know
Secured debt is a debt that's secured by pledging an asset for collateral and means someone took on a debt and backed it with a piece of property they own.3 min read
2. Why is Secured Debt Important?
3. Reasons to Consider Not Using Secured Debt
4. Reasons to Consider Using Secured Debt
What is Secured Debt?
Secured debt is a debt that's secured by pledging an asset for collateral. It means someone took on a debt and backed it with a piece of property they own. The lender puts a lien on the asset that's been pledged, giving them the ability to legally take the asset if the debt is defaulted on.
Common examples of a secured debt include a mortgage and a car loan. The car or the house become the security asset for the debt that you took on. If you default on the payments for any reason, the lender has the right to take you to court in order to recover the asset.
A lender usually requires the asset be maintained and/or insured to a set standard in order to maintain asset value. For example: a lender who issues an auto loan requires the borrower to obtain a specific type and level of insurance coverage. In the event of a crash, the lender can recover most or all of the outstanding loan balance from the insurance company. A similar requirement is made of those obtaining a mortgage. Homeowner's insurance is a requirement in the event a natural disaster strikes and severely damages the home.
A secured creditor, or the issuer of the loan, protects its position through an action known as perfection. In most states, the lender perfects its interest by issuing a lien against the property. State law determines how the lien is recorded, but most liens are perfected in ways that include:
- Real property: Most states require the lender to perfect its lien by recording mortgages and deeds of trusts in the county the property is located.
- Vehicles: lenders perfect liens against trucks, cars, and motorcycles by filing with the state department of motor vehicles and putting a notation on the title.
- Tangible personal property: Equipment, furniture, household goods, and more are perfected by filing a financial statement. The financing statement identifies the lender, borrower, and the collateral for securind the debt.
The lender must perfect the lien in order to enforce its claim against the property. If the borrower files bankruptcy and the lien is not perfected, the lender can be treated as an unsecured creditor and lose all of its interest in the property.
Why is Secured Debt Important?
Getting large amounts of money to buy an asset is difficult when there's nothing to secure the loan. Lenders don't like to give money to a borrower without some kind of guarantee that they'll get their money back. Using an asset to secure the loan shows the lender that the borrower is serious about making repayment. If the borrower gets behind on payments or stops making payments, the lender can take the property back through legal avenues and eventually recover the money.
Reasons to Consider Not Using Secured Debt
The main reason to not use secured debt is the risk of the loss of the asset. An agreement is made between borrower and lender that the borrower is good for the debt and is pledging an asset to back up their word. If there is any hint of uncertainty with the ability to repay the loan, then one should not get into this type of a loan. Losing an asset through legal action does a lot of damage to a credit rating. It can take years to undo and affects getting credit in the future.
Reasons to Consider Using Secured Debt
Securing a debt with an asset can help to lower the interest rate on a purchase. Lower interest rates up front means less interest paid over the life of the loan. It's also the best way to buy a home or a car when there's not a lot of cash available.
If you need help with understanding secured debt, you can post your question or concern on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.