Secured liability definition
/What is a Secured Liability?
A secured liability is an obligation for which payment is guaranteed by an asset. If the borrower cannot repay the liability within the contractually designated time period, the lender can seize the asset and sell it in order to obtain the funds needed to settle the liability. If the amount received from sale of the asset exceeds the amount of the associated debt, then the lender pays the excess amount to the borrower. In this situation, the asset is classified as collateral for the debt.
Characteristics of a Secured Liability
The key characteristics of a secured liability are as follows:
Collateral requirement. The debt is backed by a tangible or intangible asset (e.g., real estate, equipment, inventory, securities). If the borrower defaults, the lender can take possession of the collateral.
Lower risk for lenders. Since the loan is secured by an asset, lenders face less risk compared to unsecured liabilities. This often leads to lower interest rates for borrowers.
Priority in bankruptcy. In case of bankruptcy, secured creditors get paid first from the proceeds of the liquidated collateral before unsecured creditors receive anything.
Examples of Secured Liabilities
There are many types of secured liabilities. Here are several examples:
Line of credit. Most lines of credit for smaller businesses are secured liabilities; lenders may insist on using all of a firm’s assets as collateral on these loans, though they may only require that its accounts receivable and inventory be used.
Car loan. A car loan is always structured as a secured liability, since the underlying vehicle is designated as the collateral in the loan agreement. The lender can seize the car if the borrower defaults.
Equipment loan. A business may take out a loan in order to purchase a specific piece of equipment. If so, the lender usually designates the equipment as collateral, and so can seize it if the borrower defaults.
Mortgage. A mortgage is always structured as a secured liability, since the underlying property is designated as the collateral in the mortgage agreement. The lender can seize the property if the borrower defaults.