What is Secured Debt?
Secured debt is debt that is collateralized.
How Does Secured Debt Work?
Mortgages are the most common example of secured debt: the bank lends you the money and the bank has the house as collateral.
Here's another example: let’s assume you would like to borrow $100,000 to start a business. Even if you have an excellent credit rating, a bank may be reluctant to lend you the money because it may be left with nothing if you default on the loan. Thus, although banks may attempt the lengthy and expensive process of suing you in that circumstance, the bank may require $100,000 of collateral in order to lend you the money. This collateral might consist of financial instruments, houses, cash or even objects such as art, jewelry or other items. You might also pledge your business receivables as well. When you pledge these assets, you are securing the debt.
If you do in fact default on the loan, the loan agreement gives the lender the right to seize and then sell the collateral in order to recover any outstanding balance.
Why Does Secured Debt Matter?
Secured debt gives lenders a sense of security, which is why secured debt often receives better interest rates than unsecured loans. The lender bears less risk. However, the type and amount of security required for a given loan is often a matter of negotiation between the lender and borrower. For instance, a lender might require a borrower to collateralize any assets purchased during the loan period. In some cases, collateral for one obligation can also be collateral for other obligations (this is called cross-collateralization). This often occurs in real estate transactions, where a house collateralizes more than one mortgage.