What is an Unsecured Note?
In the finance world, an unsecured note is corporate debt that does not have any collateral attached. Unsecured notes are not the same as debentures, which are also unsecured corporate debt (but debentures usually have insurance policies that pay out when the borrower defaults).
How Does an Unsecured Note Work?
Let’s say Company XYZ plans to purchase another company for $20 million. It only has $2 million in coupon of, say 5%, which is very attractive to investors. However, because there is no associated with the , there is a chance that if the acquisition doesn't work out and Company XYZ stops making payments, they may have little compensation if the company is liquidated., so it $18 million in unsecured notes. The unsecured notes have a
If that collateral attached, the has nothing to seize when the borrower stops making the payments. Sure, the lender can sue and recover his or her that way, but that is a more expensive and time consuming.doesn't have any
Why Does an Unsecured Note Matter?
An unsecured note is backed by little more than a promise to pay. Unsecured notes are riskier than secured(and even ) because the does not have the ability to seize an right away if a borrower fails to repay the (and there isn't even an insurance policy backing the ). Creditors may of course sue to obtain access to accounts or other assets if the borrower has not paid, but that is more expensive than requiring up front.
Regardless, this lack of security increases the creditor’s risk, which in turn increases the interest rates on unsecured notes.