What Exactly is a Car Loan Security Agreement?
What is a Car Loan Security Agreement?
As we discussed in last week’s post, a car loan is just an auto loan where the lender requires the borrower to give the lender a security interest in the car. The lender will have you sign something called a security agreement, which an agreement that establishes the lender-borrower relationship and describes what collateral is provided for the debt.
The security agreement contains a description of the collateral, identifies the borrower, establishes the debt obligation and states that unless the borrower keeps making payments on the loan the lender can take the collateral back and sell it to pay off the debt . It’s a legal contract where the borrower agrees to give the lender a security interest in the car in exchange for money or a line of credit. Through this legal agreement, the borrower promises that if you don’t live up to the terms of the agreement – that is, you don’t pay for the car – the lender will repossess the vehicle, sell it, and apply the sale proceeds to the borrower’s outstanding balance.
To perfect a security interest in a vehicle, lenders will often file a UCC Financing Statement.
Why is a Security Agreement Necessary in Car Financing?
A security agreement is an integral document to auto financing. The importance of the security agreement is representative of the nature of the auto financing. It benefits both parties and is used as a tool by the lender to ensure that the borrower pays off the loan by giving the lender the right to repossess the vehicle if the borrower defaults on the financing agreement.
Simply put, the security agreement lays out the terms of the loan agreement with the vehicle as collateral. The security agreement gives the lender the right (such as repossession) should the borrower fail to pay off the loan and default on the agreement. The lender may not gain ownership of the collateral until the borrower defaults on the financing.
Essential Elements of a Car Loan Security Agreement
The initial of the security agreement is generally a statement of the parties to the agreement: "This Security Agreement (the agreement) dated [Insert Date]. Lender: [Lender Name]. Borrower: [Your Name]."
The next part of the security agreement is usually a description of the collateral for your loan: "Grant of Security Interest. For value received, Borrower grants a continuing security interest (the ‘Security Interest’) to Lender in the following property (the ‘Collateral’):."
A brief description of the collateral or a written attachment generally follows the description of the secured property: "(a ‘Loan’), that certain [insert nature of automobile, e.g. 2005 Honda Accord], VIN No. [insert vehicle identification number] (the ‘Vehicle’). The Vehicle, whether now or hereafter existing or acquired, and all accessions, attachments, accessories, repairs, replacements, substitutions, and improvements to the Vehicle, howsoever acquired, owned whether free and clear of all other prior liens, if any, or subject to the terms and conditions set forth herein or in any other document evidencing the Loan are referred to as the ‘Collateral.’"
The next section of the security agreement details any events that may cause a default under the agreement: "Events of Default. An ‘Event of Default’ occurs when Borrower defaults in payment of any installment or other amount due under the Loan (the ‘Loan Amount’), fails to maintain insurance as described herein, sells or otherwise transfers the Collateral, fails to perform or observe any other material term, covenant, condition, or agreement of this Agreement within thirty (30) days after notice from Lender of such failure, or after a bankruptcy or other event of insolvency occurs. It is an ‘Event of Default’ if any of the Collateral is rendered uncollectible under the provisions of its insurance policy. It is also an ‘Event of Default’ if a court enters a judgment, order, or injunction that requires Borrower to use the Collateral in a manner that is not authorized by the Loan or this Agreement."
Sometimes the security agreement is accompanied by an assignment of title. The assignment is a separate document transferring the title of the secured property from the borrower to the lender. The lender then signs the document stating its acceptance of the assignment.
Security Agreements and the Approval of Car Loans
Federal regulations mandate auto lenders to vet the creditworthiness of their applicants. A credit check is standard procedure for all car loan approvals and security agreements are part of that. Security agreements assure lenders of the value of their collateral by creating a security interest or lien which gives them the right to take possession of the asset if the borrower defaults. They give the lender additional leverage when attempting to determine whether or not to approve an auto loan.
When a borrower needs to borrow money, they typically have collateral, something of value they can offer the lender to cover the cost of the loan in the event they default. In the case of auto loans, the value of the collateral is the vehicle the borrower wants to purchase and use to get to work, school or run errands. Unless the lender has some assurance their collateral will not depreciate , the lender may deny the loan altogether or charge higher rates and fees.
"Creditworthy" is an often-used but little-understood term used to rate the borrower’s ability to pay back their debt obligations. It is not some arbitrary figure but rather a ratio or multiple constructed from an amalgamation of factors. Key among these are credit scores, assets, income, debt burden, employment and ownership of assets of value. When the lender requests a credit report, they do so to analyse this information because it is difficult to assess worthiness without knowing the number of loans and credit accounts a borrower has, how much each debt is, how much they owe and how long they have had the debts. Whether or not the applicant is a resident, non-resident alien, first time buyer or has recently filed for bankruptcy all factor into the approval process.
While a credit check can tell the lender a great deal about the borrower’s financial situation, it cannot determine if their claims about their finances to be true – to verify their creditworthiness. This is the purpose of the security agreement. The lender uses it as part of their risk assessment to decide whether to approve an auto loan.
Obstacles Borrowers Encounter with Security Agreements
When a borrower misunderstands the terms of a security agreement, such a conflict could lead to a foreclosure, and this occurs more frequently than might be imagined. The following are other circumstances that could lead to such an outcome.
Consumer’s Disagreement With Repossession Reason or Process If the borrower feels that the repossession process has not been executed correctly, he or she should hire an attorney. Many times a borrower is unable to prevent repossession but could still require the lender to pay damages if it was not done according to the security agreement.
Exceedingly aggressive lenders. For example, security agreements pique lending aggressiveness and allow a lender access to the collateral through rapid repossession, without proper notice or court orders. Borrowers may feel helpless because they reasonably trust the lender will make the "correct" decisions. But all lenders have financial interests at stake.
Interest and Loan Terms When the interest rate is higher than average, the lender usually has an increased interest in recovering the vehicle and the full amount owed. Borrowers sometimes get confused about the length of the loan, the monthly payments, and interest. They may believe they can afford to default and obtain the vehicle back through a loan modification. In the event of bankruptcy, the Security Agreement requires full disclosure of all debts. Therefore, even if the loan is disputed by the borrower, it must be listed as a secured debt in the bankruptcy petition. The Bankruptcy Code has a two pronged test (presumption of abuse) which is dispositive of the bankruptcy case. Courts have little power to allow debtors to retain property in bankruptcy. Therefore, the borrower most likely loses the vehicle due to the requirements of the Bankruptcy Code.
Implications of the Law Regarding Security Agreements in Car Loans
Enforcement of security agreements and repossession of collateral is subject to legal proceedings. The most basic protection is the requirement that, unless the debtor consents in writing to a waiver of the requirement of court enforcement, the lender must go to court in order to obtain judgment (or other legal authorization) in order to enforce a claim under a security agreement.
Lenders can be tempted to violate the law, especially when it comes to promissory notes secured by security agreements. Sometimes lenders are flat-out mistaken about their legal rights under these agreements.
However, violations of the law carry legal penalties for the lender. The borrower has a right to damages, costs of litigation, and attorneys’ fees if the lender violates a security agreement. If the lender violates a "security interest" agreement, which is a specific kind of security agreement, the borrower may be entitled to punitive damages, as well . That means that the borrower may be able to recover money for the actions the lender took just to enforce his or her rights under the security interest agreement. Although punitive damages key for how egregious the lender’s actions were, they may cause the lender to face huge legal penalties.
Because lenders take so many of these agreements as a matter of course, it can be easy for them to forget to comply with the law when repossessing the collateral or otherwise enforcing the security agreement. It can help to have a consumer attorney on your side to enforce your rights in these situations.
The Uniform Commercial Code (UCC) governs security agreements generally. In fact, it is important to remember that security agreements arise under the UCC, and are different from any kind of security interest outside of the UCC.
Of particular importance is UCC Section 9-609, Enforcement of Security Interests. This section protects the debtor and shall not be violated in repossession situations.