Secured loan

A secured loan is a loan backed by a specific asset that the lender can seize and sell if the borrower fails to repay. The asset is the collateral, and the lender's legal claim over it is a security interest — variously called a charge, lien, pledge or mortgage depending on the asset and the jurisdiction.

The essential mechanic is that security gives the lender a second source of repayment. The first source is always the borrower's cash flow. Security determines what happens when that fails.

Loans without this backing are unsecured — the lender has only the borrower's promise and a general claim ranking alongside other unsecured creditors.

What security actually changes

Security does not make a borrower more likely to repay. It changes what the lender recovers if they do not. The distinction is precise, and it drives pricing.

Expected loss on a credit exposure is:

Expected loss = probability of default × loss given default × exposure at default

Security reduces loss given default. It leaves probability of default largely unchanged.

Worked example. A $100,000 loan with a 5% probability of default:

Unsecured:  LGD ≈ 90%   →  EL = 0.05 × 0.90 × 100,000 = $4,500
Secured at 70% LTV on property, LGD ≈ 25%
                        →  EL = 0.05 × 0.25 × 100,000 = $1,250

The $3,250 difference in expected loss is roughly 3.25 percentage points of annual margin — which is approximately the rate gap you would expect between the secured and unsecured versions of the same loan. The pricing difference is not a discount for good behaviour; it is arithmetic on recovery.

This also explains why security cannot rescue a bad loan. If probability of default is 60% rather than 5%, no loss-given-default improvement makes the exposure sensible. Collateral is the second way out, never the first.

Loan-to-value and haircuts

The core measure of security adequacy is the loan-to-value ratio:

LTV = loan amount ÷ value of the collateral

An $80,000 loan against a $100,000 property is 80% LTV, leaving a 20% equity cushion. Lenders apply a haircut — the discount between an asset's market value and the amount they will lend against it — reflecting how reliably the asset can be valued, how quickly it can be sold, and what it fetches in a forced sale.

• Cash deposit / savings lien: 90–100% typical LTV | Immediate liquidity | Minimal enforcement difficulty (set-off)
• Government securities: 80–95% typical LTV | High liquidity | Low enforcement difficulty
• Residential property: 70–80% typical LTV | Moderate liquidity | High enforcement difficulty (legal process, slow)
• Commercial property: 50–70% typical LTV | Low liquidity | High enforcement difficulty
• Listed shares: 50–70% typical LTV | High liquidity | Low enforcement difficulty (volatile)
• Motor vehicles: 50–70% typical LTV | Moderate liquidity | Moderate enforcement difficulty (depreciating)
• New equipment: 50–70% typical LTV | Low liquidity | Moderate enforcement difficulty
• Specialised machinery: 20–40% typical LTV | Very low liquidity | High enforcement difficulty (thin resale market)
• Inventory: 20–50% typical LTV | Variable liquidity | High enforcement difficulty (perishable, movable)
• Receivables: 60–85% typical LTV | Liquidity depends on debtor quality | Moderate enforcement difficulty

Ranges are indicative and vary widely by market, lender policy and asset condition.

Types of security

• Mortgage — a charge over land or buildings, registered at a land registry.
• Fixed charge — attaches to a specific identified asset; the borrower cannot dispose of it without the lender's consent.
• Floating charge — hovers over a changing pool of assets such as stock and receivables, allowing the borrower to trade normally until the charge crystallises on default. A debenture typically combines fixed and floating charges over a company's whole undertaking.
• Pledge — the lender takes physical possession of the asset, as with pawned goods or warehoused commodities.
• Chattel mortgage / hypothecation — a charge over movable property, with the borrower retaining possession and use. This is the standard structure for vehicle and equipment finance.
• Lien over deposits — the lender blocks a savings or fixed deposit account held with it, the cleanest form of security available.
• Assignment of receivables — the borrower's right to be paid by its customers is transferred to the lender.
• Guarantees — strictly recourse rather than security, since they add another person to sue rather than an asset to seize.

Perfection and priority

Creating a security interest is not the same as making it effective against everyone else.

Perfection is the step — usually registration in a land registry, companies registry or movable collateral registry — that makes the security valid against third parties. Unregistered security may be perfectly good between lender and borrower and worthless against a liquidator or a competing lender.

Priority determines who gets paid first from sale proceeds. A first charge ranks ahead of a second; a second charge holder receives only what remains after the first is satisfied, which in a forced sale is frequently nothing. Priority normally follows registration order rather than agreement date, which is why registration timing matters operationally.

Many countries have introduced movable collateral registries in the last two decades, allowing security over equipment, vehicles, inventory, receivables, crops and livestock to be registered and searched electronically. This has meaningfully expanded secured lending to businesses whose assets are not land.

Valuation

Security is only worth its realisable value, which is rarely its book or market value.

• Independent valuation by a qualified valuer, rather than the borrower's estimate or purchase price
• Forced sale value rather than open market value — assets sold under enforcement fetch a discount, commonly 20–30% below market, sometimes far more for specialised items
• Revaluation cycles, since property values move and equipment depreciates. A five-year-old valuation is not a control.
• Margin maintenance on volatile collateral such as shares, where a price fall can require the borrower to post additional security

Enforcement

Enforcement is a legal process, not a self-help remedy. The sequence typically involves formal demand, a statutory notice period, appointment of a receiver or repossession, sale by public auction or private treaty, and application of proceeds.

Two consequences follow the sale:

• Shortfall. If proceeds do not cover the debt, the borrower normally remains liable for the deficiency, subject to jurisdiction-specific limits.
• Surplus. If proceeds exceed the debt and enforcement costs, the excess belongs to the borrower and must be returned.

Enforcement is slow and expensive. Legal fees, valuation, storage, auctioneer commission and months of lost interest all erode recovery, which is why realistic loss-given-default assumptions are well below the headline LTV suggests.

Secured vs. unsecured

• Backing: Specific pledged asset (Secured) vs. Borrower's promise only (Unsecured)
• Interest rate: Lower (Secured) vs. Higher (Unsecured)
• Amount available: Larger, constrained by asset value (Secured) vs. Smaller (Unsecured)
• Tenor: Longer (Secured) vs. Shorter (Unsecured)
• Approval basis: Cash flow plus security (Secured) vs. Cash flow and credit history (Unsecured)
• Setup cost: Valuation, registration, legal fees (Secured) vs. Minimal (Unsecured)
• Speed: Slower (Secured) vs. Faster (Unsecured)
• Risk to borrower: Loss of the asset (Secured) vs. Credit file damage, legal claim (Unsecured)

Common pitfalls

• Lending on collateral rather than cash flow. A well-secured loan to a business that cannot service it still produces a loss after enforcement costs and delay. Security changes severity, not likelihood.
• Stale valuations. Values move; a file that has not been revalued in years does not reflect actual cover.
• Unperfected security. Registration failures surface at exactly the moment the security is needed.
• Illiquid collateral at generous LTV. Specialised machinery valued at replacement cost may realise a fraction of that figure at auction.
• Depreciating assets on long tenors. A five-year loan against a vehicle depreciating faster than the balance amortises goes underwater midway through.
• Ignoring prior charges. A search before disbursement is cheap; discovering an existing first charge afterwards is not.
• Over-collateralisation. Taking security far exceeding the exposure ties up assets the borrower needs to raise other funding, and can push a viable business into distress.