creditor

What It Is

A creditor is an individual or institution that lends money or services to another entity under a repayment agreement.

How It Works

There are generally two types of creditors: personal and real. Personal creditors are people who loan money to friends or family. Real creditors are financial entities who require borrowers to sign legal contracts that grant the creditor some sort of collateral -- e.g. car, house, jewelry --  if the borrower fails to repay the loan.

Let's look at a scenario with a real creditor, XYZ Bank, to whom you go to for a loan. If you are approved and they lend you money, XYZ Bank becomes your creditor.

Individuals and companies can have several creditors at any given time, for many different types of debt. Additional examples of creditors who extend credit lines of money or services include: utility companies, health clubs, phone companies and credit card issuers.

Not all creditors are considered equal. Some creditors are considered superior to others (senior), while others are subordinate.

For example, if Company XYZ issues bonds, the bondholders become creditors senior to Company XYZ's shareholders. And should Company XYZ then go bankrupt, the senior bondholders are entitled to repayment before the shareholders are.

Why It Matters

If a borrower does not repay the credit, creditors have the legal right to:

1Sue to obtain access to accounts or other assets if the borrower has not paid.
2Place liens on the borrower's assets. This means the borrower cannot sell the assets without paying the creditor first.

The distinction between senior debt and subordinated debt is crucial for creditors and investors. Senior debt is considered less risky than subordinated debt because it is first in line to be repaid once means for repayment have become available. That means that the interest rate paid on senior debt is lower than that paid on unsecured debt.

Source: Investing Answers

What It Is

Secured creditor is a lender that provides collateralized debt.

How It Works

Mortgage lenders are the most common example of secured creditors: They lend you money and keep the house as collateral.

Here's another example: You would like to borrow $100,000 to start a business. Even if you have an excellent credit rating, a bank may be reluctant to lend you the money because it may be left with nothing if you default on the loan. Thus, although banks may attempt the lengthy and expensive process of suing you in that circumstance, the bank may require $100,000 of collateral in order to lend you the money. This collateral might consist of financial instruments, houses, cash, or even objects such as art, jewelry, or other items. You might also pledge your business receivables. When you pledge these assets, you are making the lender a secured creditor.

If you do in fact default on the loan, the loan agreement gives the lender the right to seize and sell the collateral in order to recover any outstanding balance.

Why It Matters

Secured creditors often provide lower interest rates than unsecured creditors because they have collateral on their side. They bear less risk as a result. However, the type and amount of security required for a given loan is often a matter of negotiation between the lender and borrower. For instance, a lender might require a borrower to collateralize any assets purchased during the loan period. In some cases, collateral for one obligation can also be collateral for other obligations (this is called cross-collateralization). This often occurs in real estate transactions, where a house collateralizes more than one mortgage.

Source: Investing Answers

What It Is

An unsecured creditor is a lender or any entity to which a company or individual owes money for services provided. That creditor, however, does not have any collateral from the borrower.

How It Works

If you borrow money from XYZ Bank, XYZ Bank becomes your creditor. Utility companies, health clubs, phone companies, and credit card issuers can all be creditors if you have contracts with them or if they have performed services for which you have not yet paid.

If the creditor has claim to some of your assets -- say, a deposit you made, a lien on your house, the title to your car -- that creditor is a secured creditor. If the creditor has no ability to claim some of your assets when you don’t pay (this is often the case with credit cards), the creditor is unsecured. If you have borrowed money from a bank, the bank may ask you for collateral as a way of securing the loan.

Why It Matters

An unsecured creditor takes on more risk than a secured creditor because it does not have the ability to seize an asset right away if a borrower fails to repay the debt. Creditors may of course sue to obtain access to accounts or other assets if the borrower has not paid, but that is more expensive than requiring collateral up front.

Regardless, this lack of security increases the creditor’s risk, which in turn increases the interest rates on unsecured loans.

Source: Investing Answers