Financial Friday: Secured Debt

What Is Secured Debt?

Secured debt is debt-backed or secured by a collateral to reduce the risk associated with lending. If the borrower on the loan defaults on repayment, the bank seizes the collateral, sells it, and uses the proceeds to pay back the debt. Assets backing debt or a debt instrument are considered a form of security, which is why unsecured debt is considered a riskier investment than secured debt.

KEY TAKEAWAYS

• Secured debt is debt that is backed by collateral to reduce the risk associated with lending.
• In the event a borrower defaults on their loan repayment, a bank can seize the collateral, sell it, and use the proceeds to pay back the debt.
• Because loans that are secured have collateral backing them, they are considered less risky than loans that are unsecured, or that have no collateral backing.
• The interest rate on secured debt is lower than on unsecured debt.
• In the event of a company's bankruptcy, secured lenders are always paid back before unsecured lenders.

Understanding Secured Debt

Secured debt is debt that will always be backed by collateral, which the lender has a lien on. It provides a lender with added security when lending out money. Secured debt is often associated with borrowers that have poor creditworthiness. Because the risk of lending to an individual or company with a low credit rating is high, securing the loan with collateral significantly reduces that risk.