Secured creditor definition
/What is a Secured Creditor?
A secured creditor is a lender that has placed a lien on certain assets of a borrower. A lien allows the creditor to seize those assets designated as being the collateral of the borrower. When a lien has been recorded against an asset, the creditor can move quickly to acquire the asset in the event of a payment default by the borrower. The creditor can then liquidate the asset in order to obtain payment. In the event of a bankruptcy, secured creditors must be repaid in full before any funds are made available to unsecured creditors.
Characteristics of a Secured Creditor
The main characteristics of a secured creditor are as follows:
Collateral requirement. The loan or credit is backed by specific collateral, such as property, equipment, inventory, or other tangible or intangible assets. The creditor has a legal claim or lien on this collateral.
Priority in repayment. Secured creditors have priority over unsecured creditors in the repayment hierarchy during bankruptcy or liquidation proceedings. They are typically repaid first using the proceeds from the sale of the collateral.
Legal agreement. A secured creditor enters into a legal agreement, such as a mortgage, security agreement, or lien document, which specifies the terms of the security interest.
Risk mitigation. The presence of collateral reduces the risk for the secured creditor, as they have a tangible asset to seize if the borrower defaults. Lower risk often leads to lower interest rates compared to unsecured credit.
Rights to collateral. In the event of default, the secured creditor has the right to seize, repossess, and sell the collateral to recover the owed amount.
Perfection of security interest. The secured creditor must perfect their security interest by complying with legal formalities, such as filing a UCC-1 financing statement (in the U.S.) or registering the interest under relevant jurisdictional laws.
These characteristics collectively provide the secured creditor with stronger protections and a better chance of recovering their funds compared to unsecured creditors.
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Example of a Secured Creditor
For example, a mortgage lender is a secured creditor, because it has a lien on the property for which it is providing a mortgage. If the mortgage holder does not pay on a timely basis, the lender takes back the property. The lender is no longer a secured creditor as soon as a borrower pays off a mortgage, obligating the lender to remove the lien from the borrower’s property.
Unsecured Creditors
An unsecured creditor does not have a lien on the assets of a borrower. If the borrower defaults, this class of creditor cannot seize any assets in compensation. Instead, it must pursue voluntary repayment by the borrower, or wait for a distribution from the residual assets of the borrower, if it ever enters bankruptcy protection. Examples of unsecured creditors are suppliers and credit card issuers.