Security interest is a term that refers to the rights of a lender to gain control of pledged property in the event that a borrower defaults on a loan. While there are exceptions, when a debtor defaults on a secured loan, the lender has the right to seize control of the collateral pledged as security for the loan, and sell it as a means of settling the outstanding balance of the loan. Depending on the current laws and regulations in place, there may be limits on how the lender goes about gaining control of the pledged property, and how the payment of debt is actually executed.
The degree of security interest that a lender holds in a given pledged asset is often limited to the amount of the outstanding debt. This means that in the event that a borrower defaults after making the majority of payments according to the loan agreement, the laws of the land may still allow the lender to seize the collateral and offer it for sale. Once the sale takes place, the debt is settled from the proceeds of the sale, and any remaining balance is forwarded to the debtor.
In the event of a bankruptcy, a lender holding a secured debt often has precedence over any unsecured debts that the debtor may owe. For example, if the debtor declares bankruptcy and the court begins to determine what assets may be sold to partially settle outstanding debts, the lender with a security interest would be considered before any creditors holding unsecured debt, such as credit card companies. As a result, the lender with a claim on collateral has a much better chance of receiving a higher settlement, especially if the asset pledged as security is among those the court deems as eligible for sale.
Holding security interest as part of a loan arrangement does provide benefits for everyone concerned. Typically, pledging collateral allows the borrower to obtain a more competitive rate of interest and possibly more attractive terms and provisions within the loan agreement. For the lender, the pledging of security minimizes the potential of loss in the event the borrower does default, since legal action can be implemented to gain control of the pledged asset and sell it to settle the debt. Ideally, the outcome of the business relationship is that the borrower repays the loan balance on time and in full, and the lender never has to invoke his or her security interest as a means of recouping on the investment.