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What is a Purchase Money Security Interest? And Why Should I Care?

The legal definition of a purchase-money security interest is one in which the purchase-money collateral secures a purchase-money obligation. 

Wait, what!? 

That’s right, the definition of purchase-money security interest is one in which the purchase-money collateral secures a purchase-money obligation. 

Okay, so what is a purchase-money obligation, smart guy? 

I thought you would never ask.  A purchase money obligation is an obligation of an obligor incurred as all or part of the price of the collateral or for value given to enable the debtor to acquire rights in, or the use of the collateral if the value is in fact so used. Simple, right? 

No!

Simply put, a purchase-money security interest is characterized by a transaction in which a lender loans money to a debtor to allow the debtor to acquire rights in certain goods.  Those same goods are then pledged to the lender as collateral security for the loan.  Purchase-money security interests are useful for lenders in that, when done properly, they can allow lenders to obtain priority over an existing security interest in certain collateral.

How is that fair!?  You mean an existing creditor can be primed by a Johnny-come-lately creditor?   

Yes, and the reasoning is that, absent the new loan, the debtor would have never acquired rights in the collateral in the first place.  So, basically, no harm, no foul.  From a debtor’s perspective, a purchase-money security interest can allow the debtor to expand its borrowing capacity (and in turn, its asset holdings) by allowing the debtor to borrow against specifically acquired assets.  Everyone wins! 

But wait, there’s more!  Purchase money security interests can also be traps for creditors failing to follow the exact statutory procedure for obtaining such a security interest.  They can also be traps for existing creditors failing to monitor their collateral.  If existing creditors are not diligent, it is possible that all of the debtor’s property is actually purchase money collateral pledged to a new lender and the existing creditor’s collateral has been sold rendering a once secured loan unsecured!