Security interest definition

What is a Security Interest?

A security interest is a lien on an asset that has been pledged as collateral on a loan by a borrower. The lender can use this security interest to claim the asset if the borrower defaults on a loan agreement, thereby paying off the loan. Security interests are common with any asset-based lending, such as mortgages and car loans.

Advantages of a Security Interest

There are several advantages to having a security interest, which are as follows:

  • Reduced risk (lender). A security interest allows a lender to take precedence in being paid back if a borrower goes bankrupt. In this situation, the secured lender is paid first, while unsecured creditors are paid if there are any residual assets left. When a lender requires security interests from all of its borrowers, this substantially reduces its overall risk of loss.

  • Lower interest rate (borrower). An advantage of having a security interest from the perspective of the borrower is that the lender’s risk is reduced, so that a lower interest rate may be offered.

  • Easier to obtain loans (borrower). When a borrower can provide a lender with a security interest in unencumbered assets, it may be easier to obtain a loan. When a lender has adequate collateral, it is more likely to grant a loan request.

Example of a Security Interest

For example, Mr. Smith takes out a $300,000 loan to buy a townhouse, with the townhouse as collateral on the loan. The lender takes out a lien on the property. Mr. Smith then stops making loan payments, so the lender uses its security interest in the property to take possession and sell it. The proceeds are then used to pay off the loan.

Related AccountingTools Courses

Corporate Finance

Treasurer's Guidebook