Secured debt is any type of indebtedness where the outstanding balance is covered by some item of value. By acquiring the right to take control of the item of value, a lender is able to guarantee a return on the amount of the loan or the line of credit that was extended to the recipient. Essentially, the ability to acquire the item of value makes the debt secure for the lender.
The use of secured debt is common in lending situations. Bank loans are an excellent example. Banks will extend loans for a number of purposes, such as the purchase of a vehicle or to finance an improvement project on a piece of property. In exchange for granting the loan, the debtor pledges some type of collateral. The collateral will be an item of value that could be turned over to the creditor in the event that the recipient of the loan fails to make payments on the outstanding balance. This arrangement is usually referred to as secured loan or a secured debt loan.
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Secured loans are often attractive to the recipient for several reasons. First, the rate of interest is often slightly lower than with non-secured loans. This means that over time, the debtor will pay back less money in finance charges and interest rates.
Second, the secured debt structure often provides an incentive to make payments on time. Depending on the terms of the loan agreement, the lender could declare the loan to be in default after so many late payments, or if no payments are made within a given time frame. Making the payments on time helps to ensure the debtor does not lose a valuable asset.
Last, the secured debt arrangement may allow the debtor to use the item that is being acquired as the collateral on the loan. Essentially, this means that the lender has paid for the collateral, and is holding a lien against it until the loan balance is paid in full. For the debtor who is using a secured loan to purchase a car, this means that even if the loan goes into default, there is not much chance of the lender coming after other assets not associated with the collateral on the loan.