Security Interest - Explained
What is a Security Interest?
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What is a Security Interest?
A security interest is a form of property interest in real or personal property. It is given by the owner of the property to provide assurance to a third party that the property owner will perform an obligation or pay a debt. Generally a security interest arises when one party loans money to another party. The borrower provides a security interest in property to give assurance that she will repay the loaned funds. Often the money borrowed is used to purchase the property securing the loan. If the borrower fails to repay the loan, the lender may seek to take possession of and sell the property securing the loan. The proceeds from sale of the property are then used to repay the debt.
Note: The most common types of security interest are mortgages of land and security interests in personal goods under Article 9 of the UCC.
Next Article: Benefits of a Security Interest in Collateral Back to: SECURED TRANSACTIONS
How does the pledge of security interest in the collateral provide additional security to the creditor?
If the debtor fails to repay the debt in accordance with the debt agreement, the creditor may repossess or take possession of the collateral. The creditor may then sell the collateral to obtain cash (liquidate the asset). The creditor may pay expenses of the sale, then apply proceeds to pay off the debt. Any proceeds from the sale left over after paying the debt is returned to the debtor.
The creditors ability to seize and sell the collateral securing the debt provides a great deal of security to the creditor. The secured creditor can feel more comfortable that she will be repaid for the loan or extension of credit made to the debtor. An unsecured creditor cannot directly repossess assets of the debtor who fails to repay the loan or extension of credit; rather, they have to sue the debtor and attempt to recuperate their money through the judicial system.
What is Article 9 of the UCC?
The Uniform Commercial Code (UCC) provides model laws governing commercial transactions in goods. Every state has adopted the UCC, with little change, as the statutory law of the the state. Article 9 of the UCC provides the laws governing security interests and secured transactions. The remainder of this lecture series will reference Article 9 provisions concerning security interests.
What is a Lien and how does it relate to a security interest?
A security interest is a type of lien. A lien is a debt that is specifically attached to an asset and provides the lien holder with a security interest in that asset. A security interest generally arises at the time of lending money through agreement. A lien, however, may arise through a number of methods. Other examples of liens include:
- Mechanics Liens
- Materialmans Liens
- Judgement Liens
For example, a mechanics lien arises when a workman performs services on the assets of a third party. If the third party fails to pay for the work, the workman may enforce a lien and retain the asset until it is paid. Likewise, a worker who works on a home or piece of real estate may place a materialmans lien on the property. Lastly, suing someone may result in a judgment against that individual. The holder of the judgment may attach the judgment to property of the liable defendant. The judgment holder now has a judgment lien on the assets. In all of these situations, the holder of the lien may repossess the property and sell it at auction. The proceeds from sale are used to pay the cost of sale and the debt owed. Any exceed proceeds are returned to the debtor.
Discussion: What role do security interests play in a vibrant economy? What role do security interests play in the assessment of risk in finance?
Practice Question: Arthur is considering borrowing money from Brand Bank. He is trying to evaluate whether the bank will lend him the money and at what interest rate. What is a primary consideration for the bank in determining whether to loan the money to Arthur?