Learn more about how secured loans work and how they can affect you.
Definition and Examples of a Secured Note
A secured note is a loan or corporate bond secured by some type of collateral. This collateral makes it a less risky investment. The collateral gives investors a way to recoup their funds. If you are unable to pay back the loan, the lender can put a lien on your collateral until you do. In some cases, they may be able to repossess it. Corporations often issued secured notes to raise capital debt. Since the debt is secured, borrowers often receive a lower interest rate. That’s because the collateral protects the lender against the risk of default. Common types of collateral are real estate, equipment, and investments. For example, if you take out a mortgage, your home is the collateral for the loan. For an auto loan, your car is the collateral. If you choose to take out a secured note, it’s important to select your collateral wisely. If the loan goes into default, you are at risk of losing whatever collateral you used to back it.
How a Secured Note Works
If you default on a secured loan, your collateral can be liquidated to repay your debt. For this to work, the collateral must be something that’s worth the same amount as the loan. For example, when you buy a home using a mortgage, the loan is secured by the house and property. This gives your lender a tangible asset to claim if you are unable to pay back your home loan. If you default on the mortgage, the lender can seize your home. If you can pay back the mortgage, your lender will release any claim to your property. Otherwise, you could lose your home. If the collateral doesn’t fully cover the cost of what you owe, the lender can try to get the rest of their money back. They would do this by pursuing what is known as a “deficiency judgment” against you. If they win, you could have to pay back the remainder of the loan out of pocket.
Secured Debt vs. Unsecured Debt
In comparison, an unsecured note is riskier for the lender. Borrowers often pay higher rates to compensate for the additional risk.
Types of Secured Notes
Many common types of loans are secured notes.
Mortgage
When you take out a mortgage, the home you purchase is used as collateral to secure the loan. If you default on your mortgage, your home will go into foreclosure, and you could lose your home.
Auto Loan
Like mortgages, when you take out an auto loan, the car you purchase is used as collateral for the loan. If you don’t repay your loan, the lender has the right to repossess your car. The same is true for loans taken out on boats, motorcycles, and any other type of vehicle.
Home Equity Loan
Like a mortgage, a home equity loan uses your house as collateral for a secured loan. You may get a one-time lump sum, or you could use your house to back a line of credit. Either way, if you can’t repay your loan, the lender can foreclose on your home.
