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1.5.3 Security Taken in Credit Transactions

The law commonly distinguishes between secured and unsecured credit generally and among secured credit by the type of collateral. Collateral may be either real or personal property of the debtor. The security interest, given by contract, grants the creditor the right to seize the collateral to satisfy the remaining debt if the debtor defaults. For example, credit sales contracts usually give the seller and its assignees a security interest in the goods purchased. If the buyer defaults on the payments and the security interest is valid, the creditor can repossess the goods and sell them to satisfy the outstanding debt.189 A creditor that has no security interest can ultimately collect on its debt by obtaining a judgment on the debt and attaching the debtor’s property pursuant to the judgment. However, this process is generally more costly and time-consuming than self-help repossession. Moreover, much of a debtor’s property may be immune to attachment because of state exemption statutes.190

The existence of security on a credit contract is largely independent of other credit terms. Both fixed-term and open-end credit generally may be secured, as may both loans and credit sales. Moreover, unless prohibited by law, any kind of creditor may require security. Yet the kind of security that may be required legally frequently depends on the type of transaction involved.191 For example, a small loan licensee or a retailer operating under a RISA may be prohibited from taking a security interest in real estate.

Security interests are important because they shift the parties’ risks. A creditor that obtains a valuable security interest, such as a lien on a motor vehicle, faces a much lower risk of nonpayment than does an unsecured creditor, and well-secured loans such as automobile loans frequently carry a lower interest rate than unsecured credit such as the average credit card account. Conversely, the consequences for a debtor of defaulting on a loan are much greater if the loan is secured. A borrower who defaults on a home or automobile loan may lose the car in short order. Faced with such consequences, a borrower may make payments on a loan even if meeting the payments leads to severe privation. Indeed, prior to legal restrictions on the practice, small loan lenders and retailers frequently took security interests in household goods of negligible cash value simply because of the threat of repossession was effective in obtaining payment.192

Special usury statutes are often aimed at transactions involving a particular kind of collateral. Many states have special RISAs that address only the sale of motor vehicles. Other statutes apply only to manufactured home sales.

Footnotes

  • 189 {181} See National Consumer Law Center, Repossessions (9th ed. 2017), updated at www.nclc.org/library.

  • 190 {182} See generally National Consumer Law Center, Fair Debt Collection (8th ed. 2014), updated at www.nclc.org/library.

  • 191 {183} See, e.g., Ohio Rev. Code § 1321.12 (prohibiting small loan licensees from taking security interest in real estate); Pa. Con. Stat. tit. 12, §§ 6305(b)(11) (prohibiting creditor under state RISA from taking security interest in residential real estate), 6310 (restricting security interest to goods sold).

  • 192 {184} See 16 C.F.R. pt. 444 (effective Mar. 1, 1985) (forbidding creditors from taking a non-purchase money security interest in most household goods); National Consumer Law Center, Unfair and Deceptive Acts and Practices §§ 6.2.1–6.2.2 (9th ed. 2016), updated at www.nclc.org/library; Richard R.W. Brooks, Credit Past Due, 106 Colum. L. Rev. 994, 1003–1006 (2006) (discussing fringe lender’s motivations in taking a security interest).