It’s important to understand the difference between secured and unsecured creditors when you’re trying to improve your credit score. A secured creditor is a lender who has a security interest in your collateral, which is usually your home or car. An unsecured creditor is a lender who doesn’t have a security interest in your collateral.
Secured creditors are usually more lenient when it comes to late payments because they know they can repossess your collateral if you don’t make your payments on time. Unsecured creditors, on the other hand, are less forgiving of late payments because they don’t have the same security.
That’s why it’s important to make sure you make your payments on time to both types of creditors. If you’re having trouble making your payments on time, you should try to negotiate with your creditors to get more flexible payment terms.
What is a secured creditor?
A secured creditor is a creditor who has a legal right to have their debt repaid before unsecured creditors. This type of creditor typically has some form of collateral, such as a car loan where the car serves as collateral, that gives them this priority. In the event of a bankruptcy, secured creditors will typically be paid first from the proceeds of any asset sales.
If there are not enough proceeds to cover all debts, then unsecured creditors may not receive anything. As a result, it is important for consumers to understand the difference between secured and unsecured creditors before taking on debt.
Secured creditors fall into two subcategories:
- those with a fixed charge on an asset(s) of the business
- those with a floating charge
Fixed charge
A fixed charge is a type of security interest that gives the lender the right to take possession of and sell the asset if the borrower defaults on the loan. This type of charge is typically used to finance the purchase of tangible assets such as machinery, vehicles, or real estate. The fixed charge gives the lender a greater degree of security than a simple personal loan, since they can recoup their losses by selling the asset.
However, it also means that the borrower has less flexibility in how they use the asset. For example, a borrower who takes out a loan to buy a car may be required to keep the car insured at all times and may not be able to sell it without the lender’s permission. In general, a fixed charge is best suited for borrowers who are confident that they will be able to repay the loan and who do not need to use the asset as collateral for another loan.
Floating charge
A floating charge is a type of security interest that gives the creditor the right to take possession of the debtor’s assets if certain conditions are met, such as the debtor going into insolvency. In the event of insolvency, the creditor holding the floating charge (as long as it was registered after 15 September 2003 in England/Scotland/Wales or 27 March 2006 in Northern Ireland) will be placed further down the hierarchy for payment.
This means that other creditors will be paid before the holder of the floating charge. However, if the assets are sold while the debtor is still solvent, then the holder of the floating charge will be paid first. Floating charges are typically used by banks and other financial institutions when loaning money to businesses. They provide a higher level of protection for the lender in case the borrower is unable to repay the loan.
What is an unsecured creditor?
An unsecured creditor is a person or entity to whom money is owed and who does not have any security or collateral for the debt. In the event of a bankruptcy or insolvency, unsecured creditors are paid after secured creditors, such as lenders with mortgages or car loans. The order in which unsecured creditors are paid may also depend on the type of bankruptcy filed.
However, even if an unsecured creditor is entitled to payment, there is no guarantee that they will actually receive any money. This is because there may not be enough money available to pay all of the creditors in full. When this happens, creditors may only receive a partial payment known as a dividend or no payment at all. As a result, it is important for people to understand the risks involved before lending money to someone who may be considering bankruptcy or insolvency.
Examples of secured and unsecured creditors
Here are a few examples of both secured and unsecured creditors. Some of the more common types include:
Secured Creditors
- Banks that hold a fixed charge on assets
- Invoice Finance companies that hold a charge over the sales ledger
- Lenders with a charge over assets in the inventory
Unsecured Creditors
- HMRC*
- Contractors
- Customers
- Suppliers to the insolvent company
*HMRC are classed as an unsecured creditor, though they are classed an un unsecured creditor for some types of taxes and as a Preferential Creditors for others (Preferential Creditors get paid after Fixed Charge but before Floating Charge Holders), for example:
- HMRC are classed as an unsecured creditor for direct taxes such as Corporation Tax and Employer NICs.
- HMRC are classed as a Preferential Creditor for VAT, PAYE, CIS deductions and Employee NICs and will be paid after the primary preferential claims for wage arrears and unpaid holiday pay.
It is only when a company runs into any type of trouble financially and then it starts to struggle to pay its bills, does the presence of a secure creditor become a threat to its very existence.
When realising assets in insolvency, status is the main difference between secured and unsecured creditors. Secured creditors generally get paid in full from the sale of the asset over which they hold the charge, this is after the liquidator’s costs have been met.
Conclusion
Secured creditors and unsecured creditors are two categories of creditors that are distinguished by the type of collateral they hold as security for a loan. A secured creditor is a creditor that holds a lien or other form of security interest in the borrower’s assets, while an unsecured creditor is a creditor that does not hold any collateral.
One of the main differences between secured and unsecured creditors is the priority they have in the event of a borrower’s default or bankruptcy. In general, secured creditors have a higher priority and are more likely to be repaid before unsecured creditors. This is because the secured creditor has the right to seize and sell the borrower’s assets in order to recoup the debt, while unsecured creditors do not have this option and must rely on the borrower’s assets being liquidated or the borrower’s future income to pay off the debt.
Another difference between secured and unsecured creditors is the level of risk they face. Secured creditors typically face a lower level of risk because they have the ability to seize and sell the borrower’s assets in the event of a default. Unsecured creditors, on the other hand, face a higher level of risk because they do not have this collateral and may not be able to recover their debt if the borrower defaults.
In summary, the main difference between secured and unsecured creditors is the type of collateral they hold and the priority they have in the event of a default or bankruptcy. Secured creditors hold collateral and have a higher priority, while unsecured creditors do not hold collateral and have a lower priority.
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With over three decades of experience in the business and turnaround sector, Steve Jones is one of the founders of Business Insolvency Helpline. With specialist knowledge of Insolvency, Liquidations, Administration, Pre-packs, CVA, MVL, Restructuring Advice and Company investment.