We have explained below what is primary security and what is collateral security and how these are different.
Also Read: What is mortgage and types of mortgages
What is primary security?
In simple terms, Primary Security is that asset which is created out of the finance provided by lender. For example, in a Housing Loan, primary security is the house which has been purchased out of the bank loan. In a Cash Credit Limit, primary security is stock and book debts are primary security, for which CC limit has been granted. In a term loan for machinery, machinery is the primary security.
What is collateral security?
Collateral security is the security which is not primary security. Collateral means, secondary or additional, that means, collateral security is taken by lenders in addition to primary security to secure loan. Generally a property or other asset (like land, building, shares etc.) are taken lender to secure the loan.
When collateral security is required?
Collateral security is not taken in retail loans in normal course like housing loan, car loan, personal loan etc.
But collateral security is required by lenders in corporate loans like Cash Credit. Since in CC account, primary security i.e., stocks and book debts are at the disposal of borrower, he can sell them any time and may divert funds, additional security in the shape of immovable properties or some other assets are taken to secure loan.
Collateral security is not taken in the loans to micro enterprises and small enterprises upto one crore rupees, which are covered under CGTMSE scheme. Loans without collateral security are known as collateral free loans. (You can have a look at this article to know about CGTMSE scheme)
When there is only collateral security and no primary security?
For some types of credit facilities, there may not be primary security but only collateral security. Lenders offers these facilities without any defined purpose except for speculation. For example mortgage loans known as LAP (Loan against Property), which may be for business purpose or personal purposes but not for any specific defined purpose.
Loans, which do not have either primary security or collateral security, are known as unsecured loans. For example personal loans in which there is no primary or collateral.