Secured transactions are transactions in which a creditor has a security interest in property held by the debtor. In the event that the debtor defaults on the debt, the creditor can act upon the security interest to settle the debt. Unsecured transactions are those in which the creditor does not have a security interest and must take the debtor to court to recover the debt if the debtor fails to repay the debt in a timely fashion. One of the most common forms of secured transaction is a mortgage, in which bank lends someone money to buy a house and the house serves as the security interest.
In a secured transaction, the creditor wants to make sure that the security interest or collateral on the loan will actually satisfy the debt in the event of a problem. For example, a debtor could not offer a car as security interest for a mortgage because the value of the car at resale would likely be less than that of the house. The creditor wants to make sure that if the debtor reneges, it will be able to reclaim most of the money, rather than ending up with outstanding loans on its books which it has no hope of recovering. Secured transactions can become risky when they involve assets which may depreciate over time.
The terms of secured transactions are settled upon in a contract between the parties involved. This contract includes a security agreement which gives the creditor the right to repossess or foreclose upon the property being used as a security interest. Some examples of things which can be used to secure a transaction include real estate, cars, stock certificates, and other assets of value. The creditor determines whether or not to accept the offered collateral.
Secured transactions are the underpinning of many financial systems. Secured loans come at a lower interest rate because there is less risk to creditors. Lower interest rates and the availability of credit in turn frees up the market, which allows for economic growth over time.
In the event that a debtor cannot repay debts, creditors involved in secured transactions are first in line for recovering the monies they are owed. When they seize and resell assets, any money above the amount required to satisfy the debt is returned to the debtor. This money can be used to pay creditors with unsecured loans. If the proceeds from the sale do not cover the loan, the remainder of the debt becomes unsecured and the creditor is on the same footing as other lenders who made unsecured loans.