12 Apr What is Secured Debt?
Posted at 9:15 pm in Secured Debt by Brian Price
This is for education only. Not to be considered to be legal advice.
One of the biggest problems people have is understanding what constitutes a secured
debt. Many consumers encounter documents that are quick and easy to sign. “Just sign here,
initial here, and boom!” Done with everything. However, the problems begin when the consumer
fails to make the contracted payment on time or does not make payments at all. Then the creditor
whips out the agreement and begins to exercise the contractual muscle that exists in the
agreement. Nowhere is this muscle more apparent than a secured debt agreement.
A secured debt is where a creditor or lender loans money to a debtor. In exchange for the
loan, the lender takes a security interest in property. If the debtor fails to pay as set forth in the
agreement, then the lender is free to take the property in which the security interest exists. A
secured debt can also be created in the court system. I will cover that type of secured debt in
Many people understand the concept of a secured loan because the average consumer has
purchased a home or automobile at some point in life. The mortgage company gives money to
the homeowner to purchase a home. The homeowner agrees to make payments to the mortgage
company. The homeowner continues to make payments (usually for 15 to 30 years) until the
home is paid off. Up until the loan is paid off, the bank can foreclose or take back the home if the
homeowner fails to make the required payments.
Many people are also not aware that a homeowner can lose a home to the lender even if
mortgage payments are being made on time. This does not happen very often, but it can happen.
Most of the time a lender will take out insurance on the home and the insurance premiums is
included in the mortgage payment. In some instances, the homeowner may be responsible for
obtaining adequate insurance, keeping that insurance, and providing proof of that insurance to
the lender. In the event that the homeowner fails to get and keep insurance then that is considered
to be a breach of contract and the lender has the right to foreclose on the home.
The lender can also foreclose if the home is being used for any other purpose than
everyday living. For example, let’s say that Tom purchases a nice home for $250,000.00. He puts
down 10%, or $25,000, and takes out a mortgage for the remaining $225,000.00. The home is
worth $255,000.00. Now, suppose a few years later Tom wants to open a car repair business in
his garage. He still owes $190,000.00 on the mortgage and the home is worth $200,000.00 before
the garage is converted into a business repairing automobiles. After the conversion, the home’s
value drops to $185,000.00 with the mortgage still being $200,000.00. The lender is now upset
because the value of the home is now less than what is owed on it. Furthermore, the lender
provided the money to purchase the home to be lived in as a residence not converted or used as a
business. The lender can foreclose on the residence based upon Tom using it as a business as
well as a home.
Another common example of a secured loan is when someone goes to purchase an
automobile. The bank provides the funds to buy the automobile. The bank receives a security
interest in the automobile. The bank or lender can repossess or take back the automobile if the
payments are not made as called for in the loan agreement. And like the house, the lender
requires adequate insurance to protect their interest until the automobile is paid off in full.
There are also other ways in which a creditor can get a security interest in property. A
finance or loan company can take an interest in a debtor’s property in exchange for a loan. For
example, suppose Roger needs to go the dentist but is short on funds. He goes down to ABC
Finance Company for a $500.00 loan. He agrees to pay back $500.00 plus interest within 30
days. To help secure payment, ABC takes a security interest in Roger’s computer. If Roger fails
to pay, then ABC Finance can come pick up Roger’s computer.
Now that begs the question as to whether Roger should or should not give a security
interest to ABC Finance. ABC Finance may require that Roger provide a security interest in his
property as a requirement for obtaining the loan. Then Roger may not have much choice in the
matter if he wants to get the loan. It may benefit Roger to give a security interest to the finance
company because usually a secured loan has a lower interest rate than an unsecured loan.
The bottom line is that you need to read and understand any loan papers that you sign.
Too many people don’t even bother to read the paperwork before signing the loan agreement.
Smart consumers take the time to fully understand any business dealings beforehand.