Preferred Debt Definition
Preferred debt refers to a financial obligation that carries more preference or significance than other debts. Being a prioritized one, preferred debt needs to be paid off first. The lien position of such debt comes before other kinds of equity and debt positions. For instance, comparing the first and second mortgage, the first mortgage of a firm would be considered as a preferred debt.
A Little More on What is Preferred Debt
Interest on preferred debt is free from any taxes. Preferred debts usually cover interest on mortgages, equity line of credit, and equity loans. It also includes tax amounts that an individual or company owes to the IRS and the first position in loans taken for personal use.
Ways preferred debt can affect the resolution of a bankruptcy
When the assets of borrower or debtor are liquidated, it is necessary to discharge the obligations of preferred debt before any other debts. The secured creditors are the parties having or holding the mortgage in case the debtor goes bankrupt. A party working as a secured creditor has a portion or all of the property at the time of financing a mortgage loan. Loans taken for automobiles can also make the title holder eligible as a secured creditor with the due debt appearing as preferred debt.
If preferred debt is associated with the physical property or land, it is possible to recover outstanding debt amounts by seizing or repossessing the property. For example: the creditor can take possession of a home or automobile, and sell them for recovering the debts. Sometimes, the real estate or property’s worth would be less than that of the debt. In such case, the preferred debt holder has the right to use cash assets of the borrower during the liquidation proceedings. Based on the available assets, it can be possible that the recompensation for preferred debt doesn’t leave any capital or property for making payments for other debts or shareholders at the time of liquidation. It would be interesting to know that preferred debt come before preferred securities for making repayments. Still, there would be a payment made for preferred securities prior to shareholders obtain any dividends.
An organization records the value of preferred debt on its financial books under the liabilities section. And this could impact the financial worth of a firm in addition to its potential for getting more finances in future. As the owners of preferred debt can ascertain the return received on financing in a more effective manner, holding first mortgage gives them more leverage over secondary mortgage.