What is 'Secured Debt'

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

 

 

BREAKING DOWN 'Secured Debt'

There are two primary ways a company can raise capital: debt and equity. Equity is ownership and implies a promise of future earnings, but if the company falters, the investor may lose her principal. Lured by the prospect of better growth opportunities, investors in equity have the implicit backing of the company but no real claim on company assets. Indeed, equity holders get paid last in case of bankruptcy. Debt, on the other hand, implies a promise of repayment and has a higher degree of seniority in the case of bankruptcy. As a result, debt holders are not as concerned about future earnings as they are about liquidation value. Within the world of debt, there is one particular class of securities that has a higher seniority than unsecured debt vehicles: secured debt vehicles.

Secured Debt

In general, lenders are more concerned about the value of company assets than earnings quality because in the case of earnings decline, the company can sell assets. This is the informal course of action when firms are facing bankruptcy; however, some debt is contractually backed by specific assets. This debt is referred to as secured debt. Secured debt is a formal contract backed by assets that can be sold as collateral if the firm defaults on the loan. Due to its low risk profile, secured debt is favored among those companies with poor credit. Secured debt allows the borrower to shift the lender's focus to the liquidation value of assets rather than the borrower's creditworthiness.

Examples of Secured Debt

The most commonly cited example of a secured loan is a mortgage. Other examples include the service provided by pawn shops or the factoring of receivables. Pawn shops give the borrower a loan based on the value of whatever that borrower is willing to pawn. In this way, secured debt is at the foundation of the pawn shop business model. Many firms also make a habit of receiving funding through the financing of accounts receivable. If the company cannot make the payment, the lender can use customer receipts and promissory notes to secure repayment. Other examples include car loans and home equity lines of credit, also referred to as HELOCs,

RELATED TERMS
  1. Debt

    An amount of money borrowed by one party from another, often ...
  2. Debt Service

    The cash that is required for a particular time period to cover ...
  3. Unsecured Debt

    A loan not backed by an underlying asset. Unsecured debt includes ...
  4. Junior Debt

    Junior debt is debt that is either unsecured or has a lower priority ...
  5. Preferred Debt

    Debt that is considered more important or has priority over other ...
  6. Cost of Debt

    The effective rate that a company pays on its current debt. This ...
Related Articles
  1. Investing

    Will Corporate Debt Drag Your Stock Down?

    Borrowed funds can mean a leg up for companies or the boot for investors. Find out how to tell the difference.
  2. Investing

    What's a Debt Security?

    A debt security is a financial instrument issued by a company (usually a publicly traded corporation) and sold to an investor.
  3. Investing

    Explaining Debt Service

    Debt service is a measure of a person or entity’s use of cash to pay interest and principal on debt obligations.
  4. Investing

    Explaining Debt

    Debt is any amount a borrower owes a lender.
  5. Personal Finance

    Why Debt Isn’t Always a Bad Thing

    When managed properly, debt can be used to achieve a higher overall rate of return.
  6. Insights

    How Countries Deal With Debt

    For many emerging economies, issuing sovereign debt is the only way to raise funds, but things can go sour quickly.
  7. Small Business

    Total Debt to Total Assets

    Total Debt to total assets, also called the debt ratio, is an accounting measurement that shows how much of a company’s assets are funded by borrowing. In business, borrowing is also called leverage.
  8. Financial Advisor

    The 4 Best Debt Reduction Services

    It can be tricky to find the best debt reduction services for your financial situation. These top 4 debt consolidation firms help make the process easier.
  9. Investing

    What are Debt Instruments?

    A debt instrument is a documented financial obligation that enables the issuer to raise funds by borrowing money and repaying it in the future.
RELATED FAQS
  1. What are the main categories of debt?

    Learn about the different types of debt available for consumers including secured debt, unsecured debt, revolving debt and ... Read Answer >>
  2. What is the difference between secured and unsecured debt?

    Understand the difference between secured and unsecured debt and how the reliability and trustworthiness of the issuing entity ... Read Answer >>
  3. What is the difference between secured and unsecured debts?

    Learn the differences between secured and unsecured debt; discover how banks buffer risks associated with each type of loan ... Read Answer >>
  4. What's the difference between debt consolidation and debt management or debt settlement?

    Learn about different ways of handling debt when you become overwhelmed, including debt consolidation, debt management and ... Read Answer >>
  5. When should a business avoid debt financing?

    Read about the optimal use of debt in a business capital structure and how to know when a business should avoid further debt ... Read Answer >>
  6. Why would you look at a company's net debt rather than its gross debt?

    Learn the difference between net debt and gross debt, how to calculate debt using a company's financial statements and why ... Read Answer >>
Hot Definitions
  1. Free Cash Flow - FCF

    A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents ...
  2. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  3. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  4. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  5. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  6. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing ...
Trading Center