Secured Debt

What is a secured debt? When a borrower gets a loan by pledging an asset as collateral, it is known as a secured debt. The asset pledged has some tangible value and could be a car, a boat, stock portfolio, a home, etc. The amount loaned out in a secured debt is usually based on the value of the collateral. If the borrower defaults on repayment of the loan, the creditor holds the right to take possession of the asset held as collateral. The creditor then becomes the owner of the asset and may retain, sell, or modify the asset as per his/her wishes. A contractual agreement is necessary for a secured debt.

Every creditor takes a risk when lending money. The reward for the risk is the interest earned on the loan. Sometimes, a creditor may be reluctant to lend money to a person due to their poor credit history. In such cases collateral can help get a favorable decision. A house mortgage is a typical example of secured debt. If the debtor cannot repay the debt, the creditor takes possession of the house and may sell it to recover some or all of the debt.

Advantages of Secured Debt

• ndividuals with low credit scores can obtain a loan more easily if they are willing to pledge an asset. Secured debts are instruments which help loan applicants with poor credit histories.
• The guarantee of an asset as collateral lowers the interest rate in a secured debt, as compared to an unsecured debt. This results in lower repayment installments.  
• The interest paid on the loans is tax deductible in the case of some secured loans, such as mortgages.

Disadvantages of Secured Debt

• Failure to repay secured debt allows the lender to reclaim the asset held as collateral. This is the biggest setback of this type of loan. The  purpose of getting a loan is defeated when this happens.
• The debtor may become liable to pay the difference if the sale of collateral does not cover the loan amount.
• Foreclosure (loss of property held as collateral), and repossession (loss of car, or other valuable goods held as collateral) can hurt a debtor’s credit rating more than a bankruptcy.

How to prevent foreclosures 

Increasing awareness and knowledge on foreclosures can help to prevent foreclosures. Many people face foreclosures simply because they are unaware of the options available to save their home. Freddie Mac/Roper carried out a poll of 2,031 U.S. homeowners in October 2005. According to this poll around six in every ten homeowners were unaware of the foreclosure prevention options offered by the lender.
[Source: http://www.fdic.gov/about/comein/files/foreclosure_statistics.pdf ]

To prevent foreclosure, a debtor must:

• Contact the lender as soon as he feels that he will not be able to make the mortgage payment
• Respond to all the correspondence from the lender
• Consult a HUD approved housing counselor to learn about mortgage rights.

For more information on tips to avoid foreclosure, please check http://www.hud.gov/foreclosure/ .   

How to prevent car/goods repossessions
 Sometimes, due to some unavoidable reasons like a job loss or an illness, a debtor runs the risk of defaulting on car loan payments. According to Lehman Brothers survey, 4.5% of auto loans procured in 2006 were at least 30 days delinquent [Source: The Wall Street Journal ]. To avoid the possibility of car repossession a debtor can:

• Contact the lender and work out a deal to adjust the defaulted amount and continue with the rest of the payment.
• Try to pay any overdue amount and settle the outstanding loan balance.
• Maintain a record of all correspondence from the lender.

If it is not possible to avoid repossession, the debtor must make sure that the lender has served a written notice within 14 days of repossession stating:

• The date of repossession of the goods,
• Estimated value of the repossessed goods
• That the repossessed car/goods cannot be sold until after 21 days from the notice served.

The debtor can get back their goods if all amounts owed are settled, including the enforcement expenses, within this grace period of 21 days. Once this grace period is over the lender can sell the car/goods at a reasonable rate to recover the loan. For more information on the proceedings of repossessions go to www.cclcnsw.org .

Secured debts, or any other type of debt, requires proper debt management. Increasing awareness of budgeting and financial matters can help determine what one can afford. This can go a long way in improving personal financial health. For free credit counseling and information on managing personal finances contact CESI.