What Is Secured Debt? Definition, Examples, & Impact

What Is Secured Debt? Definition, Examples, & Impact

As a scientist, you're likely used to weighing risks and making calculated decisions in your field. But when it comes to financing your business or making major purchases, navigating the world of secured debt can be a new undertaking, and quite often a challenge. Especially if you're not well-versed in finance.

Secured debt is an important concept to understand because it's often involved in loans and financing purchases, and it can have significant implications for your business's financial health. 

In simple terms, secured debt is backed by collateral, such as a car or a home. This collateral serves as a guarantee to the lender that they will be able to recoup their losses if you default on the loan.

But what does this mean for you? How can secured debt help or hinder your business? And how does it compare to unsecured debt, which doesn't require collateral? 

In this blog post, we'll explore the answers to these questions and provide a broad overview of secured debt, so you can make informed decisions about your financing options.

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Understanding Secured Debt & Its Importance

Secured debt is a type of debt that is backed by collateral or security, such as property, assets, or investments. In other words, it is a loan that is guaranteed by a specific asset that the borrower owns.

Secured debt provides the lender with a form of security, as they can seize and sell the collateral if the borrower defaults on the loan repayments.

The importance of this type of debt lies in the fact that it is generally easier for borrowers to obtain than unsecured debt, as the collateral serves as a form of guarantee and security for the lender.

Having this added layer of security baked into the agreement can sometimes result in lower interest rates and more favorable loan terms for the borrower. But more often it is used as a way for lenders to secure a loan they are granting to a borrower with a poor credit history, reducing the risks that come with lending to a company or individual who, in the lender’s eyes, might default.

In some cases, the use of collateral can help borrowers obtain larger loans, as lenders are often more willing to extend credit when there is a lower risk of default.

It’s important that borrowers need to be cautious when taking on secured debt, as defaulting on the loan can result in the loss of the collateral, which can have serious financial consequences. 

We recommend that you carefully read and understand the terms of the loan agreement, including any clauses regarding the collateral, before signing on the dotted line.

Examples of Secured Debt

Secured debt can include a variety of financial instruments:

  • Secured loans: A type of loan that is backed by collateral. Collateral is an asset that the borrower pledges as security for the loan. In the event that a borrower defaults on the loan, the lender can seize the collateral and sell it to recoup their losses.
  • Auto loans: When you take out an auto loan to purchase a car, the car serves as collateral for the loan. If you default on the car loan, the lender can repossess the car and sell it to recoup losses.
  • Home equity loans: A type of secured debt that allows you to borrow against the equity in your home. The loan is secured by the value of your home, which means that if you default on the loan, you’ll end up in foreclosure, as the lender can seize your home and sell it.
  • Mortgages: A type of loan that is used to purchase a home or other real estate property. The property itself serves as collateral for the loan, which means that if the borrower defaults on the loan, the lender can foreclose on the property and sell it, just like if a borrower defaults on their home equity loan payments.
  • Lines of credit: A line of credit allows the borrower to draw funds as needed up to a certain limit. Similar to a credit card, the borrower only pays interest on the amount they borrow, and the line of credit can be reused as the borrower pays it back. Secured lines of credit are backed by collateral, which means that the lender can seize the collateral if the borrower defaults on the loan.
  • Secured credit cards: Some credit cards are secured, which means that you have to put down a deposit that serves as collateral for the credit limit. If you default on the credit card payments, the lender can use your deposit to cover the losses. A secured credit card is also an example of a secured line of credit.
  • Bonds: A bond is a type of debt security that a company or government issues to raise capital. Bonds typically have a fixed interest rate and a maturity date, at which point the borrower must repay the principal. Some bonds are secured by collateral, such as assets owned by the borrower or revenue from a specific project. In the event of default, the bondholders can seize the collateral.

We’re going to focus on secured loans more in this article, since secured loans can play a large role in equipment leasing and financing, as well as other business activities.

Secured Loans

Like secured debt, a secured loan is backed by collateral, and often involves the use of liens. 

Liens are a legal claim on an asset that serves as collateral for the loan. When a borrower takes out a secured loan, they pledge an asset as collateral to the lender, who places a lien on the asset in order to secure the loan.

Lenders offer loans to individuals or businesses in exchange for repayment with interest, which is how a profit is made. Loans can be used for different purposes, including purchasing a home or car, starting a business, or paying for education.

It’s important to note that while all secured loans are a form of secured debt, not all secured debt takes the form of a loan. For example, a bond can be a form of secured debt—a bond is a type of debt security that corporations, governments, or other organizations can issue to raise capital.

While secured loans involve pledging collateral, most of them will be asset-specific, meaning that borrowers will only need to pledge one asset to secure the loan.

However, this can depend on their creditworthiness, and lenders may require liens on multiple assets. In some cases, they may require a lien on all of a borrower’s assets. This is referred to as a blanket lien.

A blanket lien gives the lender the right to take possession of any or all of the borrower's assets if they default on the loan.

It can be a huge problem for the business if the borrower defaults on their loan repayment and the lender seizes all of their assets. The collateral that was pledged to secure the loan, such as a house or a car, is often critical to the operations of their company.

Unsecured Debt

Unsecured debt is a common form of debt that is not backed by collateral. This means that if the borrower defaults on the debt payments, the lender cannot seize any property to recover their losses.

Instead, the lender may opt to send the debt to collections or report delinquency to credit bureaus, leading to adverse effects on the borrower's credit score.

Despite the potential risks, unsecured debt products are favored by many due to their seamless application process and swift funding times. They are considered attractive as they do not require collateral for approval.

However, there are some drawbacks to unsecured debt. These products are often associated with higher interest rates since they pose a more significant risk to the lender. This is because the lender has no collateral to fall back on in case of default.

Additionally, lenders may require borrowers to have good or excellent credit to qualify for competitive financing.

One of the most significant advantages of unsecured debt is its versatility. For instance, personal loans can be utilized for various purposes, ranging from debt consolidation to unexpected expenses. Credit cards, on the other hand, offer convenience and flexibility for day-to-day purchases and expenses.

Examples of Unsecured Debt

Unsecured debt comes in many forms and can be used for various purposes. While it offers convenience and flexibility, it can also carry potential risks such as higher interest rates and credit score impacts. Some examples of unsecured debt include:

  • Personal loans: An unsecured loan that can be used for a wide range of things, such as consolidating debt, making home improvements, or covering unexpected expenses. Personal loans typically have a fixed interest rate and a set repayment term.
  • Student loans: A type of unsecured debt that helps students pay for higher education, including tuition, fees, books, and living expenses. Federal student loans typically have lower interest rates and more flexible repayment options than private loans. Private student loans may require a co-signer or higher credit score to qualify. Student loans are notoriously difficult to repay, particularly if the student has a high debt-to-income ratio or experiences financial hardship.
  • Signature loans: A type of unsecured personal loan that is backed only by the borrower's signature and promise to repay the loan. These loans typically have higher interest rates than secured loans, and lenders may require a good credit score to qualify.
  • Medical debt: Unsecured debt that arises when you receive medical care and are unable to pay the resulting bills. Medical debt can be reported to credit bureaus and can negatively impact your credit score.
  • Credit cards: A revolving line of credit that allows you to make purchases up to a certain credit limit. You are required to make monthly payments on the outstanding balance, and interest is charged on the unpaid balance. Credit cards offer convenience and flexibility, but they can also be a source of high-interest debt if not managed responsibly.

Before taking on any unsecured debt, make sure to understand the terms and conditions and ensure that you can afford to make the required payments.

Secured vs. Unsecured Debt

The key difference between secured and unsecured debt is the inclusion of collateral. Secured debt is backed by collateral, which can be an asset or property that the borrower pledges to the lender in order to secure the loan.

The collateral serves as a form of security for the lender in the event that the borrower is unable to repay the loan, and the lender can seize and sell the collateral to recover their losses.

Unsecured debt, in contrast, is not backed by collateral. This means that the lender does not have any specific asset or property to seize and sell if the borrower defaults on the loan. Because unsecured debt is considered riskier for lenders, it often comes with higher interest rates and more stringent eligibility requirements.

Because there is no security involved, unsecured loans are inherently more risky for the lender and have more rigorous requirements to manage that increased risk, making it more difficult to obtain an unsecured loan. You typically need to have a strong history of credit use and a good credit score to get an unsecured loan.

However, these types of loans can appear more attractive to the borrower. You don’t need to pledge collateral and the loan can usually be approved more quickly. That said, an unsecured loan will come with a higher interest rate and stricter terms.

It’s typical for personal loans to be unsecured, but there are unsecured loans available for businesses too.

It can never hurt to learn more about secured debt vs. unsecured debt, since the differences can have significant implications for both borrowers and lenders. Let’s get back to secured debt.

Debt Priorities

In the case of a default or bankruptcy, who gets paid first? One important aspect of secured loans is that they give lenders a priority claim on the asset over other creditors.

When a company files for bankruptcy, its assets are sold off to pay back its creditors. In this process, secured lenders always have priority over unsecured lenders. This means that if there is not enough money from the sale of assets to pay back all creditors, secured lenders will be paid back in full before any payments are made to unsecured lenders.

Simply put, secured debt gives lenders a higher level of protection in the event of default, which is reflected in their priority status during bankruptcy proceedings.

On the other hand, unsecured debt doesn’t include any collateral, so the lender has no property to seize to recover their losses. As a result, unsecured lenders have a lower level of protection, which is reflected in their lower priority status during a bankruptcy proceeding.

If there are not enough proceeds from the sale of assets to pay back all secured lenders, they may be able to go after other assets of the company or individual, depending on the situation. However, if there are not enough proceeds to pay back unsecured lenders, they are left at a loss.

Which Type of Debt to Pay Off First?

As you work on paying off your debts and loans, it's important to have a strategy in place. One popular method is to prioritize paying off debts with the highest interest rates first. This can help you save money on accumulating interest in the long run, while also helping to improve your credit score by reducing your credit utilization ratio.

Known as the avalanche method, this approach involves paying off the loans with the highest interest rates first, freeing up more room in your budget to pay off the lower-interest debts. Over time, you can become debt-free and start fresh with a clean slate.

If you have unsecured debt that you can't manage, bankruptcy may be necessary to resolve it. While this can erase your legal responsibility to repay the debt, it can also have severe consequences for your credit score and future loan eligibility.

Secured debt should always be a top priority because of the risk to your property. In the event of default, the government can seize your property, and you may still be responsible for additional debts if the repossession fails to cover the full amount owed. It's important to stay on top of secured debt payments to avoid these potential consequences.

How Can Secured Debt Impact Equipment Leasing & Financing?

In equipment financing, secured loans are often used to purchase equipment or other assets, which means there is collateral securing the loan. These liens can have a significant impact on the borrower, not only during the loan’s duration, but in the event of default as well.

Secured loans can have restrictive terms and conditions that make it harder to borrow money in the future, and require liens on specific or multiple assets, meaning mission-critical equipment or property can be seized in the event of default.

Unlike taking out a loan, equipment leasing can be an easier route to take than applying for a secured or unsecured loan. Leasing companies like Excedr are not lenders, so we don’t require the same restrictive terms and conditions to provide leasing.

The equipment we provide on lease serves as collateral, so we often have an easier time working with businesses with weaker credit profiles or who need something more flexible than traditional financing.

In many instances, we can tailor lease terms to match a business's cash flow needs, and we do not include restrictive terms and conditions like collateral, blanket liens, debt covenants, or equity participation, which many lenders do require.

In Summary

Secured debt is backed by collateral. It provides lenders with a form of security, as they can seize and sell the collateral if the borrower defaults on the loan repayments. There are different types of secured debt, including secured loans, auto loans, and secured lines of credit.

It differs from unsecured debt, which does not need to be backed by some type of collateral. This means that the lender does not have any specific asset or property to seize and sell if the borrower defaults on the loan.

When it comes to secured and unsecured loans, businesses should carefully consider their options based on their specific circumstances. 

Secured loans, which are backed by collateral such as real estate or equipment, may offer lower interest rates and longer repayment terms than unsecured loans. However, they also come with the risk of losing the collateral if the business defaults on the loan.

Unsecured loans, on the other hand, do not require collateral but may have higher interest rates and shorter repayment terms. They are typically easier to obtain than secured loans, but may not provide as much funding as businesses need.

Want to know more about leasing? We’re happy to help. It’s worth comparing your options.