Legal Definitions - Purchase-money collateral

Purchase-money collateral refers to an item of property, such as goods or software, that a borrower buys using a specific loan or credit, and that very item then serves as security for the repayment of that particular loan. In essence, the money borrowed is used *solely* to acquire the collateral itself.

Here are some examples to illustrate this concept:

• Example 1: Consumer Appliance Purchase

  Imagine a homeowner who needs a new washing machine but doesn't have enough cash. They go to an appliance store and purchase a high-efficiency washing machine using the store's financing plan. The financing agreement specifies that the washing machine itself will serve as collateral for the loan.

  In this scenario, the new washing machine is the purchase-money collateral. The loan was taken out specifically to buy the washing machine, and the washing machine secures the debt incurred for its purchase. If the homeowner fails to make payments, the store (or the financing company) could potentially repossess the washing machine.

• Example 2: Small Business Equipment Acquisition

  A small landscaping company decides to expand its services and needs a new, specialized commercial lawnmower. They secure a loan from a bank specifically to buy this expensive piece of equipment. The loan agreement states that the commercial lawnmower will act as collateral for the loan.

  Here, the commercial lawnmower is the purchase-money collateral. The bank's funds were used exclusively to acquire this specific piece of equipment, and the lawnmower itself is pledged as security for the repayment of that particular loan. Should the company default, the bank has a right to claim the lawnmower.

• Example 3: Software License Financing

  A graphic design firm needs to acquire a new, industry-standard software suite for its designers. The upfront licensing cost is substantial, so the firm enters into a financing agreement with the software vendor. Under this agreement, the firm makes monthly payments, and the right to use the software (the license) is granted, with the license itself serving as security for the financing obligation.

  In this case, the software license is the purchase-money collateral. The financing was obtained specifically to acquire the right to use the software, and that right (the license) secures the firm's obligation to make the financing payments. If the firm defaults, the vendor could revoke the license.