Posted: Contributor | May 26, 2014

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Know Your Debt: What Is Subordinated Debt?

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In the world of high finance and business, subordinated debt helps companies to grow by allowing them access to funds at a higher lending risk. In the event of a bankruptcy where a company must liquidate its assets in order to pay debtors, subordinated debt is considered to have a secondary priority when it comes to the main amount of debt that must be repaid. In other words, these lenders get paid out only after the primary lenders have been satisfied. For most personal users of credit such as a homeowner, this kind of loan is sort of like a re-financing plan. You take out a "second mortgage," which is over and beyond the primary equity loan you took out to purchase your house in the first place.

Why Is Subordinated Debt Desirable?

Often a homeowner or company requires an injection of cash in order to address repairs to their home, pay for new furnishings, etc. In some cases, applying for a secured loan is impossible and the company or individual needs to pursue other options in order to bring money to the table, but without a direct injection of equity. Depending upon the level of other credit areas in which the company has borrowed, getting a new, unsecured loan may be easier to achieve. And as long as companies and individuals have the cash flow to deal with a regular repayment schedule, they can safely secure a loan.

Higher Risk Means Higher Interest Rates

Before you engage in a subordinated loan be aware that it will most likely carry a higher interest rate than a primary loan. As well, it will carry a unique repayment method that usually spans a time period far shorter than a simple equity loan. However, should the homeowner default on their payments and follow through to bankruptcy protection, the primary loan will have to be paid off first. The benefit of this is that if the homeowner encounters a shortfall, the process of debt subordination is put into play and will only become an issue once the primary debts are paid as well as any taxes owed on the property, and the charges applied by the liquidator. Having this hierarchy of debt benefits the debtor in that they may not have to pay the subordinated debt holder immediately.

When Is Subordinated Debt the Only Solution?

If you've exhausted all other means of accessing funds, you may be forced to seek this solution. Remember that lenders will examine the list of your primary debts to determine the level of risk you pose as a debtor. Depending on the depth of your debt situation, you may be simply digging yourself even deeper. But if you can handle the repayment plan, then you can indeed access the funds that lie in the equity you already own.

This is an extremely complicated subject and the rules and obligations differ from each nation and state within. Before you take on any further debt load of any sort, talk to a specialist in order to fully understand your options and obligations. You may benefit from a cash injection, but in the long run, higher interest rates may render the benefits null and void and lead to a dire financial situation.

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