What is an Unsecured Note?
How Does an Unsecured Note Work?
Unsecured notes are typically medium-term debt, the terms vary, including the interest rates, face values, maturities and other provisions.
Let’s say Company XYZ plans to purchase another company for $20 million. It only has $2 million in , so it $18 million in unsecured notes. The unsecured notes have a 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.
If that doesn't have any 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.
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
Regardless, this lack of security increases the creditor’s risk, which in turn increases the interest rates on unsecured notes.