What are the differences between a secured loan and an unsecured loan?

Answer 1

A secured loan is a loan in which you offer some or other asset to which you have right of ownership for security to the supplier of the loan in case of nonpayment.

An example is where you finance a new car and the installment sale agreement is secured by your car; if you fail to make the payments, the bank has the right to repossess the vehicle. Other examples for businesses are for instance the encumbrance of your fixed properties, trade debtors or inventory.

In case of litigation or sequestration (bankruptcy) the encumbered assets are protected from any other creditor until the credit supplier has been able to recover the loan from the sale or use of the secured asset. Two different credit providers are therefore not able to be secured by one asset, except if the asset is worth more than the two loans - normally both creditors will have to be aware of this and a rank will be established among them.

In accordance with GAAP, companies have to disclose any material encumbrances in its financial statements.

An unsecured loan is not protected and in the case of bankruptcy the creditor will have to share in a portion of the remaining estate pro rata to the other creditors instigating a claim against your estate. For instance, if your estate is worth $1,000 and you have 3 unsecured loans of $1,000 each, then each creditor will only be able to receive $333. Subsequently they will not be able to attempt to recover the remaining $667. Bankruptcy naturally affects the status of the person or legal person involved negatively.