To obtain a Bank Loan borrower has to put some assets as security against the loan amount. Security protects lenders against losses in case of default by the borrower. The Bank has the right to seize the security to recover the dues from the borrower if the borrower fails to repay the loan amount.
Types of Security
There are two types of Security, such as:
- Prime Security
- Collateral Security
Prime Securities are the assets that are directly related to loans and kept that as security. So, prime security can be the thing that is being financed. The lender keeps those assets as prime security for securing the financed amount against any default by the borrower.
For Example, in the case of a housing loan, the house is primary security and in the case of term loan for Plant and Machinery, Plant and Machinery will be primary security.
Collateral Security is the secondary security that is used when Primary Security is not sufficient to cover the whole loan amount in case of default by the borrower. This security is the additional security to the Primary Security.
Example of Prime Security and Collateral Security
- Suppose, you have borrowed a housing loan of USD 2 million from a commercial bank to acquire a residential flat. The bank asks you to mortgage the same flat against the loan. This is Called Prime Security.
- For example, the Bank finance a term loan of 80 lakh for the purchase of machinery to an industrialist. He purchases machinery worth 1 crore for his factory. The lender bank puts a stipulation for residential flat as collateral security for the above term loan. So Machinery purchase out of this term loan is prime security while the residential flat is collateral security.
When Collateral Security is needed?
- In the case of Cash -credit Limits, Stock and book debt are primary security. But the borrower may sell Stocks and book debts, so the bank requires additional security (collateral) in the form of immovable assets (building, land) to secure the loan.
- In the case of Housing loans, Car Loans, and Personal loans, collateral security are not required.
- Micro Credit doesn’t need any Collateral Security.
- Bank Loans without collateral are known as collateral-free loans.