A secured loan is a loan backed by collateral posted by the debtor usually in the form of liquid assets. If the debtor fails to repay the loan within the terms of the contract, the lending institution has the legal right to seize the assets. Posting collateral allows the debtor to borrow at a lower interest rate as the loan is less risky that it would be it were unsecured, meaning without posted collateral.
As an additional security measure, a lending institution will usually only loan up to 75% of the value of the posted collateral depending on what type of asset is posted.
If a firm takes out a loan of $1 million and posits its accounts receivable (money that other firms owe to the debtor) it would receive a loan of $750,000.00. If the firm posted its inventory it might only receive 60% of the requested amount, $600,000.00. This reduction in the amount is known as a haircut and is used to ensure repayment will occur and that the lender can recover its money if the firm fails to meet the terms of the loan.
Common Types of Secured Loans
Here are some common secured loans.
- Car loan
- Home equity line of credit
For Further Reading
- R. A. Brealey et al. Fundamentals of Corporate Finance. Toronto: McGraw-Hill Ryerson, 2012, pp. 656.
- J.Black, N. Hashimzade, and G. Myles. (2009) "Secured Loan." [Online], Available: http://www.oxfordreference.com/view/10.1093/acref/9780199237043.001.0001/acref-9780199237043-e-2790?rskey=ht6uyj&result=1, 2009 [Aug 20, 2016]
- J. Berk et al. Corporate Finance. Toronto: Pearson Canada Inc., 2012, pp. 932.
- "A Dictionary of Economics" published Oxford University Press, 2013. Edited by John Black, Nigar Hashimzade, and Gareth Myles Online version accessed [August 17th, 2017].