Loans come in two basic forms; secured and unsecured. Whether you are a lender or a borrower, you need to know what a security agreement is and how it is used.
When people talk about loans, they typically think of home loans, car loans, etc. These agreements are common, and are generally referred to as “secured loans”. They’re called “secured” because the amount of money lent to the borrower is given under the condition that if the borrower isn't able to pay it back, the lender can take possession and ownership of the secured property as compensation.
What are we talking about? A secured transaction is one that involves collateral. In order to create a secured transaction, a properly drafted agreement must be entered into. By no coincidence, these contracts are called “security agreements”. Here are answers to some general questions:
What is a security agreement? A security agreement is a specific contract used when one person (the lender or secured party) agrees to loan another party (the borrower or debtor) a specific some of money. To ensure that money is paid, the borrower grants the lender an interest in something, usually in a specific piece of property.
For example, if you go to a bank and ask for a car loan, the bank will probably ask you to sign a security agreement where by you grant the bank a lien against the car. That way, if you fail to make the payments, the bank can take possession of the car as a way to ensure they have not lost the money they lent you.
Secured and unsecured transactions? Most people have experience both secured and unsecured transactions at some point. A typical example of a secured transaction is a home or car loan, while unsecured transactions are most commonly found in the form of credit cards. If you fail to pay a credit card, the company to whom you owe the money doesn't have a security interest in any of your property. However, if you do the same with real estate, you may see your home or property go into default and foreclosure.
What needs to be included in a security agreement? There are some specific laws that govern the use of security agreements, and such a contract needs to be drafted in compliance with them. Below are some of the more important provisions you need to include:
- The Amount: How much money is being lent?
- The Collateral: What is the debtor offering as collateral should they default?
- Terms of Default: What happens if the debtor doesn't pay on time? Defining what happens and when it happens in the event of default is extremely important for the lender to protect their interests.
- Filing Provisions: In the United States, security agreements usually have to be filed in compliance with the Uniform Commercial Code. To affect this filing, it’s common for the agreement to require all parties to cooperate to ensure needed information is provided to each other.