Substitution of Collateral & Release Consent

Secured creditors and borrowers working with secured creditors always have the option to negotiate an agreement to release certain loan collateral and substitute it with new collateral. The key to these transactions is to clearly document what collateral is being released and what collateral is being substituted. Sometimes this requires the filing or recording of formal documents with a government agency.

Collateral is a legal term that refers to the specific property pledged to secure a debt or loan. A secured creditor is a person or business who has loaned money to a borrower with a promise from the borrower to pledge certain property as collateral for the loan. If the borrower does not repay the debt, the secured creditor has the right to repossess or foreclose on the collateral. Mortgage loans and auto loans are common examples of secured debt in the personal finance context, while equipment financing loans are common secured debts in the commercial realm.

A borrower under a secured debt can only provide substitute collateral with the secured creditor's consent and release. A secured creditor may be willing to agree to a substitution of collateral as long as the substitute collateral is of equal or greater value than the original collateral identified for the secured debt. The creditor is not likely to agree to a substitution that degrades the value of the debt by providing for lower value collateral.

It is critical for a borrower to obtain a written and enforceable release on the original collateral before the borrower pledges additional or substitute collateral. Failure to provide a release from the creditor could result in the borrower unintentionally providing extra collateral for no reason. The written release should be signed by the secured creditor, should clearly describe the collateral being released and should provide an effective date of the release. After obtaining a signed release on the original collateral, the borrower will then sign a new agreement pledging the substitute collateral under the same secured debt.

Secured creditors often file public documents with a government agency in order to provide protection for the creditor's claim to the collateral. For personal property, most states maintain a statewide database, often called the UCC or commercial code database, where creditors can provide notice of claims to personal property collateral, such as cars and business equipment. For real estate, each county maintains a public database for the filing of mortgage and trust deed documents relating to any property located within that county. Borrowers should also verify that the written release agreement is filed in the same government database.