Purchase money security interest

A security interest is a legal right granted by a debtor to a creditor over the debtor's property (usually referred to as the collateral) which enables the creditor to have recourse to the property if the debtor defaults in making payment or otherwise performing the secured obligations. One of the most common examples of a security interest is a mortgage: a person borrows money from the bank to buy a house, and they grant a mortgage over the house so that if they default in repaying the loan, the bank can sell the house and apply the proceeds to the outstanding loan.

Although most security interests are created by agreement between the parties, it is also possible for a security interest to arise by operation of law. For example, in many jurisdictions a mechanic who repairs a car benefits from a lien over the car for the cost of repairs. This lien arises by operation of law in the absence of any agreement between the parties.

Most security interests are granted by the person who owns the property to secure their own indebtedness. But it is also possible for a person to grant security over their property as collateral for the debts of another person (often called third party security). So a parent might grant a security interest over their home to support a business loan being made to their child. Similarly, most security interests operate to secure debts or other direct financial obligations. But sometimes a security is granted to secure a non-financial obligation. For example in construction a performance bond may secure the satisfactory performance of non-financial obligations.

The different types of security interest which can arise and the rights which they confer will vary from country to country.

A secured creditor takes a security interest to enforce its rights against collateral in case the debtor defaults on the obligation. If the debtor goes bankrupt, a secured creditor takes precedence over unsecured creditors in the distribution.

There are other reasons that people sometimes take security over assets. In shareholders' agreements involving two parties (such as a joint venture), sometimes the shareholders will each charge their shares in favor of the other as security for the performance of their obligations under the agreement to prevent the other shareholder selling their shares to a third party. It is sometimes suggested that banks may take floating charges over companies by way of security - not so much for the security for payment of their own debts, but because this ensures that no other bank will, ordinarily, lend to the company; thereby almost granting a monopoly in favour of the bank holding the floating charge on lending to the company.

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Wikipedia