Legal Definitions - partially secured debt

A partially secured debt, also known as undersecured debt, occurs when a loan or other financial obligation is backed by collateral that has a market value less than the total amount of debt owed. In such a situation, only a portion of the debt is considered "secured" by the collateral, specifically up to the collateral's current value. The remaining balance of the debt is then treated as "unsecured," meaning it is not directly protected by any specific asset. This distinction is crucial in situations like bankruptcy, as secured creditors generally have a stronger claim to their collateral than unsecured creditors do to their portion of the debt.

Here are some examples to illustrate partially secured debt:

• Example 1: Business Loan with Depreciated Equipment

  A small manufacturing company takes out a $200,000 loan to expand its operations, offering its specialized machinery as collateral. At the time the loan was issued, the machinery was valued at $220,000. However, due to rapid technological advancements and wear and tear, the machinery's market value has since depreciated to $150,000, while the company still owes the full $200,000 on the loan.

  This illustrates partially secured debt because the $200,000 loan is backed by collateral (the machinery) worth only $150,000. In this scenario, $150,000 of the debt is secured by the machinery, and the remaining $50,000 is unsecured.

• Example 2: Upside-Down Auto Loan

  Sarah purchases a new car with a $35,000 auto loan. The car itself serves as the collateral for the loan. After a year, due to typical vehicle depreciation, the car's market value has dropped to $28,000. However, because Sarah made minimal payments and also rolled over a small amount of negative equity from her previous vehicle, her outstanding loan balance is still $32,000.

  Here, the $32,000 auto loan is partially secured. The car, as collateral, is only worth $28,000. Therefore, $28,000 of Sarah's debt is secured by the car, while the remaining $4,000 is unsecured, meaning she owes more on the car than it is currently worth.