What Is a Purchase Money Security Interest (PMSI)?

A purchase money security interest (PMSI) is a legal claim that allows a lender to repossess property financed with its loan or demand repayment in cash if the borrower defaults. It gives the lender priority over other creditors' claims.

The protection provided by a PMSI is one reason for the growth of point-of-sale financing, in which a retailer offers a buyer direct financing for major purchases. In the case of default, the retailer may repossess the items purchased and may do so before any other creditors are satisfied.

[Important: The procedures permitting enforcement of a PMSI are strict and are outlined in the Uniform Commercial Code.]

How PMSIs Works

In most jurisdictions, a PMSI is valid once the buyer agrees to it in writing and the lender files a financing statement. The procedure is outlined in Article 9 of the Uniform Commercial Code (UCC), the standardized business regulations adopted by most states.

A PMSI is used by some commercial lenders and credit card issuers as well as by retailers who offer financing options. It effectively gives them collateral to confiscate if a borrower defaults on payment for a large purchase.

It also is used in business-to-business transactions. The option of obtaining a PMSI encourages companies to increase sales by directly financing new equipment or inventory purchases.

Special Considerations on the PMSI

The rules regarding a lender's use of a PMSI, as outlined in the UCC, are strict. The lender must be able to prove that the goods being seized were owned by the lender and were purchased with the lender's money. For this reason, lenders routinely pay the vendor for the goods directly, establishing ownership of them, before arranging for their sale on credit to a buyer.

For example, if a consumer was arranging to buy a custom-made sofa on credit from a furniture retailer, the retailer would put through an order with the manufacturer and pay for the sofa before finalizing the financing agreement. The retailer, not the manufacturer, is the owner selling the sofa and will be able to obtain and enforce a PMSI. In legal terms, the retailer has a "security interest" in the property just sold.

For the same reason, if the buyer has put down a security deposit on the sofa the retailer may insist that the buyer pays for it in full before the security deposit is returned. This establishes the full dollar value that the lender is entitled to demand in case of default.

Court rulings regarding PMSI claims have established the lender's right to demand reimbursement of other costs related to the purchase such as freight charges and sales taxes.

Key Takeaways

  • A PMSI gives a retailer or supplier priority for collecting on a debt in cases of default.
  • In such cases, the goods sold are serving as collateral that can be seized for nonpayment.
  • Retailers who offer point-of-sale financing are generally protected by a PMSI.