Secured Transactions: Examples & Explanations

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  • 0:05 What Is a Secured Transaction?
  • 1:46 How Do Secured…
  • 3:40 What Is Perfecting?
  • 4:55 What Is Default?
  • 6:21 Lesson Summary
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Lesson Transcript
Instructor: Ashley Dugger

Ashley has a JD degree and is an attorney. She has taught and written various law courses.

A secured transaction is any deal in which a creditor receives a security interest in the debtor's property. This lesson explains what a secured transaction is and how these transactions work.

What Is a Secured Transaction?

When a debtor borrows money, the credit transaction can be secured or unsecured. A secured transaction is any deal in which a creditor receives a security interest in the debtor's property. The creditor is known as the secured party. The secured party holds a security interest in the debtor's property in order to ensure the debtor's payment.

Let's consider an example. Credit transactions involving large ticket items, such as cars, homes or appliances, are usually secured. When I bought my new car, I borrowed money from my bank for my car loan. My loan is a secured transaction. My bank is the secured party and owns a security interest in my car. My car served as the collateral for my loan. If I fail to make payments, my bank can repossess, or take, my car in order to settle my debt.

Mortgages are another example of a secured transaction. When I took out my mortgage to buy my house, the bank acquired a security interest in my house. If I fail to pay my mortgage, the bank can leverage its interest in my house to settle my debt.

Security interests are often given in exchange for the same property for which the debtor borrowed the money, but this isn't always the case. Just note that the security interest must be capable of covering the loan. For this reason, my car can't serve as the security interest for my mortgage. The value of the car isn't enough to cover what I owe on my home loan.

How Do Secured Transactions Work?

Generally speaking, secured transactions work the same in all states. This is because all 50 states have adopted Article 9 of the Uniform Commercial Code. This set of model laws addresses all commercial transactions.

Secured transactions are executed through a contract, just like most other business deals. However, secured transactions additionally contain a security agreement. This agreement can be a separate contract or a paragraph in the loan document. It officially gives the creditor a security interest in the property and the legal right to repossess the property if the debtor fails to pay the loan. The debtor is legally obligated to make payments and also to give up the property if he or she doesn't fulfill the terms of the agreement.

Because the debtor has a lot at stake, secured transactions must meet several requirements before the creditor's interest in the collateral can be legally enforceable. The collateral becomes an enforceable part of the transaction only after the security agreement meets certain requirements. This is known as attachment and is the method by which the security interest becomes effective. The collateral attaches once the security agreement meets these requirements. It must:

  • Contain an express agreement between the debtor and the secured party
  • Be in writing
  • Be signed by both parties
  • Contain a description of the collateral that will attach
  • Contain express language granting the security interest
  • Give something of value from the secured party to the debtor

What Is Perfecting?

Once attachment is complete, the secured party should perfect the interest by filing a financing statement. Perfection gives the secured party priority over other creditors that later seek a right to the same collateral.

For example, let's say I fail to make my mortgage payments. My mortgage company has a security interest in my home and has perfected its interest. If my home is seized and sold, the money will first go toward paying my mortgage company. Other creditors will be in line behind my mortgage company. The other creditors will be on notice that this collateral is spoken for because the mortgage company publicly filed notice of its security interest with the local public records office.

Note that there are some instances when the secured party will already have possession of the collateral. This is known as a pledge. In a pledge, the debtor gives physical custody of the collateral to the secured party at the time of the agreement. This is similar to what happens when you pawn an item. The pawnshop keeps your collateral for the money they loan you. In this case, the security interest is perfected when attachment occurs.

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