Secured loan

Last updated March 29, 2024

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral, and if the borrower defaults, the creditor takes possession of the asset used as collateral and may sell it to regain some or all of the amount originally loaned to the borrower. An example is the foreclosure of a home. From the creditor's perspective, that is a category of debt in which a lender has been granted a portion of the bundle of rights to specified property. If the sale of the collateral does not raise enough money to pay off the debt, the creditor can often obtain a deficiency judgment against the borrower for the remaining amount.

The opposite of secured debt/loan is unsecured debt, which is not connected to any specific piece of property. Instead, the creditor may satisfy the debt only against the borrower, rather than the borrower's collateral and the borrower. Generally speaking, secured debt may attract lower interest rates than unsecured debt because of the added security for the lender; however, credit risk (e.g. credit history, and ability to repay) and expected returns for the lender are also factors affecting rates.^[1] The term secured loan is used in the United Kingdom, but the United States more commonly uses secured debt.

Purpose

There are two purposes for a loan secured by debt. In the first purpose, by extending the loan through securing the debt, the creditor is relieved of most of the financial risks involved because it allows the creditor to take ownership of the property in the event that the debt is not properly repaid. In exchange, this permits the second purpose where the debtors may receive loans on more favorable terms than that available for unsecured debt, or to be extended credit under circumstances when credit under terms of unsecured debt would not be extended at all. The creditor may offer a loan with attractive interest rates and repayment periods for the secured debt.^[2]

Types

A mortgage loan is a secured loan in which the collateral is property, such as a home.
A nonrecourse loan is a secured loan where the collateral is the only security or claim the creditor has against the borrower, and the creditor has no further recourse against the borrower for any deficiency remaining after foreclosure against the property.
A foreclosure is a legal process in which mortgaged property is sold to pay the debt of the defaulting borrower.
A repossession is a process in which property, such as a car, is taken back by the creditor when the borrower does not make payments due on the property. Depending on the jurisdiction, it may or may not require a court order.

UK secured loan market

Before the global economic crisis of 2006, the Financial Services Authority (FSA) estimated that the UK secured loan market had a net worth of £7,000,000,000. However, following the close of Lehman Brothers' sub-prime lender BNC Mortgage in August 2007, the UK's most prominent secured loan providers were forced to withdraw from the market.

UK secured loan market timeline (following the global credit crisis)

August 2007: Lehman Brothers closes its sub-prime lender, BNC Mortgage.
September 2007: Southern Pacific Personal Loans and London Mortgage Company close down. Kensington Mortgages withdraws from the secured loan market a day later.
October 2007: White Label Loans launches to fill the gap left by Southern Pacific Personal Loans, Kensington Personal Loans and Money Partners. Product launch is piloted by Beech Finance Ltd. and Specialist Financial Services Ltd.
April 2008: London Scottish Bank closes down entire lending division.
May 2008: Future Mortgages announce they will close for business.
June 2008: Picture Financial ceases to trade in the sector.
July 2008: Barclays ceases to sell secured loans through FirstPlus.
September 2008: Lehman Brothers declares bankruptcy.
November 2008: Bank of America subsidiary Loans.co.uk ceases to trade.
December 2008: West Bromwich Building Society subsidiary White Label Loans closes its doors to new business just fourteen months after launching and completing £60,000,000 of secured loans.
August 2009: The Finance & Leasing Association (FLA) reports that secured loan lending has fallen 84% since 2008.
October 2010: MP George Justice drafts Secured Lending Reform Bill.
December 2010: The Finance & Leasing Association (FLA) reveal secured loan lending sank to £16m.
October 2011: Whiteaway Laidlaw Bank combine with Commercial First and Link Loans to create new lender, Shawbrook Bank.
February 2012: Specialist lender Equifinance enters the market.
May 2012: Secured Lending Reform Bill fails to pass through Parliament.
July 2012: UK's first Secured Loan Index is launched by secured loan broker, Loans Warehouse, and reveals secured lending in the UK reached £150m in the first half of 2012.
September 2012: Secured loan lending is now worth £350,000,000.
December 2012: Secured Loan lender Nemo Personal Finance launches the secured loan market's lowest ever interest rates of 5.592% per annum for employed applicants and 6.54% per annum for self-employed applicants.
February 2013: Shawbrook Bank launches a secured loan product that allows loans up to 95% of property value.
1 April 2014:^[3] the Financial Conduct Authority took over formal regulation of the consumer credit market which included secured loans. Previous to this, secured loans fell under the remit of the Office of Fair Trading and firms issuing and brokering secured loans required no authorisation from the FCA. The FCA's involvement dramatically changed the secured loan landscape by putting into place more protection for the consumer.
21 March 2016: the FCA introduced The Mortgage Credit Directive^[4] which meant all regulated first-charge and second-charge mortgage contracts are treated in exactly the same way. The MCD was set up to protect consumers by governing first- and second-charge mortgage markets (as well as consumer buy-to-lets) under the same regulation, and to provide a harmonised approach to mortgage regulation across the EU. Following the introduction of the MCD mortgage brokers and advisers were required to inform their clients that a second-charge mortgage could be a better alternative to a remortgage or further advance.
2017 - 2019: Following the implementation of MCD (see 21 March 2016 timeline point) - the secured loan market saw steady growth in activity and consumer demand. At the end of 2019, the 12 month growth trend (as evidenced by the Finance and Leasing association's market statistics^[5]) showed a 20% annual growth rate.
2020 - 2021: COVID-19 had a significant impact on the secured loan market. Due to the uncertainty created by the global Coronavirus pandemic, many second charge mortgage providers paused lending. Those that continued to lend made adjustments to lending criteria to reduce credit risk . In any case, consumer demand for borrowing on a secured loan also reduced due to the economic uncertainty as a result of the pandemic. The lows of the secured loans market were reached in 2020, and 2021 showed gradual improvement as the number of new loan agreements issued increased from 486 in May 2020, to 1,910 in May 2021 (although some way short of the 2,657 of new loans issued in October 2019^[6])
2022: After what was an uncertain period of activity for the UK secured loans market, 2022 showed not only recovery post the global Coronavirus pandemic, but significant growth vs activities pre-pandemic. Whilst the UK began to see much higher rates of inflation than it had seen for a number of years, the Bank of England base rate had been increased significantly, and the UK housing market started to slow - all of which could be considered negatives - they combined to create an environment where demand and interest in secured loans increased vs earlier years. This resulted in a 52% increase in new secured loan agreements for the 12 month period ending 30th June 2022.

United States law

The United States is the global leader in security interest law with respect to personal property; in the 1940s, it was the first country to develop and enact the notion of a "unified" security interest. That concept has since spread to many countries around the world after it became evident that it is one of the reasons for why the United States has the strongest economy in the world.^{[ dubious – discuss ]}^{[ citation needed ]} For example, to raise money, American ranchers could pledge personal property like cattle in certain ways that historically were impossible or very difficult in Uruguay or most other developing countries.^[7]^{[ better source needed ]}

In the case of real estate, the most common form of secured debt is the lien. Liens may either be voluntarily created, as with a mortgage, or involuntarily created, such as a mechanics lien. A mortgage may only be created with the express consent of the title owner, without regard to other facts of the situation. In contrast, the primary condition required to create a mechanics lien is that real estate is somehow improved through the work or materials provided by the person filing a mechanics lien. Although the rules are complex, consent of the title owner to the mechanics lien itself is not required.

In the case of personal property, the most common procedure for securing the debt is regulated under Article 9 of the Uniform Commercial Code (UCC). This uniform act provides a relatively uniform interstate system of forms and public filing of documents by which the creditor establishes the priority of their security interest in the property of the debtor.

In the event that the underlying debt is not properly paid, the creditor may decide to foreclose the interest in order to take the property. Generally, the law that allows the secured debt to be made also provides a procedure whereby the property will be sold at public auction, or through some other means of sale. The law commonly also provides a right of redemption, whereby a debtor may arrange for late payment of the debt but keep the property.

How secured debt is created

Debt can become secured by a contractual agreement, statutory lien, or judgment lien. Contractual agreements can be secured by either a purchase money security interest (PMSI) loan, where the creditor takes a security interest in the items purchased (i.e. vehicle, furniture, electronics); or, a non-purchase money security interest (NPMSI) loan, where the creditor takes a security interest in items that the debtor already owns.

Related Research Articles

<span class="mw-page-title-main">Debt</span> Obligation to pay borrowed money

Debt is an obligation that requires one party, the debtor, to pay money borrowed or otherwise withheld from another party, the creditor. Debt may be owed by sovereign state or country, local government, company, or an individual. Commercial debt is generally subject to contractual terms regarding the amount and timing of repayments of principal and interest. Loans, bonds, notes, and mortgages are all types of debt. In financial accounting, debt is a type of financial transaction, as distinct from equity.

In finance, a loan is the transfer of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay interest for the use of the money.

Debt consolidation is a form of debt refinancing that entails taking out one loan to pay off many others. This commonly refers to a personal finance process of individuals addressing high consumer debt, but occasionally it can also refer to a country's fiscal approach to consolidate corporate debt or government debt. The process can secure a lower overall interest rate to the entire debt load and provide the convenience of servicing only one loan or debt.

Title 11 of the United States Code sets forth the statutes governing the various types of relief for bankruptcy in the United States. Chapter 13 of the United States Bankruptcy Code provides an individual with the opportunity to propose a plan of reorganization to reorganize their financial affairs while under the bankruptcy court's protection. The purpose of chapter 13 is to enable an individual with a regular source of income to propose a chapter 13 plan that provides for their various classes of creditors. Under chapter 13, the Bankruptcy Court has the power to approve a chapter 13 plan without the approval of creditors as long as it meets the statutory requirements under chapter 13. Chapter 13 plans are usually three to five years in length and may not exceed five years. Chapter 13 is in contrast to the purpose of Chapter 7, which does not provide for a plan of reorganization, but provides for the discharge of certain debt and the liquidation of non-exempt property. A Chapter 13 plan may be looked at as a form of debt consolidation, but a Chapter 13 allows a person to achieve much more than simply consolidating his or her unsecured debt such as credit cards and personal loans. A chapter 13 plan may provide for the four general categories of debt: priority claims, secured claims, priority unsecured claims, and general unsecured claims. Chapter 13 plans are often used to cure arrearages on a mortgage, avoid "underwater" junior mortgages or other liens, pay back taxes over time, or partially repay general unsecured debt. In recent years, some bankruptcy courts have allowed Chapter 13 to be used as a platform to expedite a mortgage modification application.

A creditor or lender is a party that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property and service. The second party is frequently called a debtor or borrower. The first party is called the creditor, which is the lender of property, service, or money.

In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment. Unsecured debts are sometimes called signature debt or personal loans. These differ from secured debt such as a mortgage, which is backed by a piece of real estate.

Hypothec, sometimes tacit hypothec, is a term used in civil law systems or mixed legal systems to refer to a registered non-possessory real security over real estate, but under some jurisdictions it may sometimes also denote security on other collaterals such as securities, intellectual property rights or corporeal movable property, either ships only as opposed to other movables covered by a different type of right (pledge) in the legal systems of some countries, or any movables in legal systems of other countries. Common law has two main equivalents to the term: mortgages and non-possessory liens.

Second mortgages, commonly referred to as junior liens, are loans secured by a property in addition to the primary mortgage. Depending on the time at which the second mortgage is originated, the loan can be structured as either a standalone second mortgage or piggyback second mortgage. Whilst a standalone second mortgage is opened subsequent to the primary loan, those with a piggyback loan structure are originated simultaneously with the primary mortgage. With regard to the method in which funds are withdrawn, second mortgages can be arranged as home equity loans or home equity lines of credit. Home equity loans are granted for the full amount at the time of loan origination in contrast to home equity lines of credit which permit the homeowner access to a predetermined amount which is repaid during the repayment period.

In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan. The collateral serves as a lender's protection against a borrower's default and so can be used to offset the loan if the borrower fails to pay the principal and interest satisfactorily under the terms of the lending agreement.

<span class="mw-page-title-main">Credit</span> Financial term for the trust between parties in transactions with a deferred payment

Credit is the trust which allows one party to provide money or resources to another party wherein the second party does not reimburse the first party immediately, but promises either to repay or return those resources at a later date. The resources provided by the first party can be either property, fulfillment of promises, or performances. In other words, credit is a method of making reciprocity formal, legally enforceable, and extensible to a large group of unrelated people.

Repossession, colloquially repo, is a "self-help" type of action, mainly in the United States, in which the party having right of ownership of the property in question takes the property back from the party having right of possession without invoking court proceedings. The property may then be sold by either the financial institution or third party sellers.

In finance, a security interest is a legal right granted by a debtor to a creditor over the debtor's property which enables the creditor to have recourse to the property if the debtor defaults in making payment or otherwise performing the secured obligations. One of the most common examples of a security interest is a mortgage: a person borrows money from the bank to buy a house, and they grant a mortgage over the house so that if they default in repaying the loan, the bank can sell the house and apply the proceeds to the outstanding loan.

A commercial mortgage is a mortgage loan secured by commercial property, such as an office building, shopping center, industrial warehouse, or apartment complex. The proceeds from a commercial mortgage are typically used to acquire, refinance, or redevelop commercial property.

Secured transactions in the United States are an important part of the law and economy of the country. By enabling lenders to take a security interest in collateral, the law of secured transactions provides lenders with assurance of legal relief in case of default by the borrower. The availability of such remedies encourages lenders to lend capital at lower interest rates, which in turn facilitates the free flow of credit and stimulates economic growth.

The vast majority of all second lien loans are senior secured obligations of the borrower. Second lien loans differ from both unsecured debt and subordinated debt.

A secured transaction is a loan or a credit transaction in which the lender acquires a security interest in collateral owned by the borrower and is entitled to foreclose on or repossess the collateral in the event of the borrower's default. The terms of the relationship are governed by a contract, or security agreement. In the United States, secured transactions in personal property are governed by Article 9 of the Uniform Commercial Code (U.C.C.).

A mortgage loan or simply mortgage, in civil law jurisdictions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any purpose while putting a lien on the property being mortgaged. The loan is "secured" on the borrower's property through a process known as mortgage origination. This means that a legal mechanism is put into place which allows the lender to take possession and sell the secured property to pay off the loan in the event the borrower defaults on the loan or otherwise fails to abide by its terms. The word mortgage is derived from a Law French term used in Britain in the Middle Ages meaning "death pledge" and refers to the pledge ending (dying) when either the obligation is fulfilled or the property is taken through foreclosure. A mortgage can also be described as "a borrower giving consideration in the form of a collateral for a benefit (loan)".

Subordination in banking and finance refers to the order of priorities in claims for ownership or interest in various assets.

A cram down or cramdown is the involuntary imposition by a court of a reorganization plan over the objection of some classes of creditors.

A business loan is a loan specifically intended for business purposes. As with all loans, it involves the creation of a debt, which will be repaid with added interest. There are a number of different types of business loans, including bank loans, mezzanine financing, asset-based financing, invoice financing, microloans, business cash advances and cash flow loans.

References

↑ Gerard McCormack (2004). Secured credit under English and American law. Cambridge University Press. pp. 16–. ISBN 978-0-521-82670-9 . Retrieved 13 December 2011.
↑ Unsecured Business Loans Guide
↑ "FCA takes over regulation of consumer credit firms". Financial Conduct Authority. 1 April 2014. Retrieved 2 May 2019.
↑ "Mortgage Credit Directive". FCA. 22 August 2017.
↑ "Latest Consumer Finance Statistics". Finance & Leasing Association. Retrieved 14 July 2022.
↑ Grundy, Marie (13 July 2021). "Blog: Things are looking up for second charge after testing times". Mortgage Strategy. Retrieved 14 July 2022.
↑ Heywood Fleisig, "Secured Transactions: The Power of Collateral," Finance and Development, 44–46.

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[McCormack2004-1] Gerard McCormack (2004). Secured credit under English and American law. Cambridge University Press. pp. 16–. ISBN 978-0-521-82670-9 . Retrieved 13 December 2011.

[2] Unsecured Business Loans Guide

[3] "FCA takes over regulation of consumer credit firms". Financial Conduct Authority. 1 April 2014. Retrieved 2 May 2019.

[4] "Mortgage Credit Directive". FCA. 22 August 2017.

[5] "Latest Consumer Finance Statistics". Finance & Leasing Association. Retrieved 14 July 2022.

[6] Grundy, Marie (13 July 2021). "Blog: Things are looking up for second charge after testing times". Mortgage Strategy. Retrieved 14 July 2022.

[7] Heywood Fleisig, "Secured Transactions: The Power of Collateral," Finance and Development, 44–46.

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