What Is a Purchase Money Security Interest (PMSI)?

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DEFINITION
A purchase money security interest (PMSI) is a legal claim that allows a lender to repossess the collateral used to secure a loan. A PMSI gives the lender priority over any claims made by other lenders.

A purchase money security interest (PMSI) is a legal claim that allows a lender to repossess the collateral used to secure a loan. A PMSI gives the lender priority over any claims made by other lenders.

A PMSI is often used by commercial lenders and retailers who sell goods on credit. If you take out point-of-sale financing at some point in the future, your lender may ask you to agree to a PMSI.

Definition and Example of a Purchase Money Security Interest (PMSI)

A PMSI gives a lender the right to repossess collateral if a borrower defaults on a loan or financial obligation. A PMSI is often used for commercial lending or by retailers who sell goods on credit.

In this scenario, the goods sold become the collateral for the PMSI. If the borrower defaults on the loan, the lender is given priority over other creditors to collect on the collateral. Suppose, for example, that you fall onto hard times and owe money to a couple of different lenders. If you default on your car loan, the original source of financing—likely the car dealership—probably had you sign a PMSI when you bought the car, so now it has the legal right to repo your car before any other debt collectors can lay claim.

A PMSI is also frequently used in business-to-business (B2B) transactions, like when a company finances new equipment or inventory. If the company stops making payments on their loan, the lender can repossess the equipment to recoup their losses.

To obtain a PMSI, the borrower must agree to grant the lender a security interest in the goods sold.

How a Purchase Money Security Interest Works

Lenders need a way to recoup their losses if a borrower defaults on a loan or financial obligation. A PMSI is one way some lenders do this. A PMSI gives lenders the legal right to pursue borrowers who default on their loans. Lenders can do this by sending borrowers to collections, taking them to court, or taking out a lien on their home or other assets.

There are strict rules surrounding how a PMSI can be used. The secured party must perfect the PMSI within 20 days of the borrower receiving the collateral.

However, the following items may qualify as exceptions:

  • Inventory
  • Consignments
  • Livestock
  • Non-uniform state amendments
  • Commercial goods

For example, a PMSI is often utilized by lenders in point-of-sale financing, when a lender allows a borrower to finance a large, upfront purchase. If the borrower defaults on their purchase, the lender has the right to repossess the items purchased before other creditors are satisfied.

There are strict rules surrounding how a lender can use a PMSI, and these guidelines are outlined in the Uniform Commercial Code (UCC).

Purchase Money Security Interest vs. Blanket Filing

Uniform Commercial Code (UCC) filings provide a means of notifying other creditors when a borrower’s assets are used as collateral for a loan. There are two primary secured transactions outlined under UCC filings—a PMSI and a blanket filing. These are ways for lenders to notify other creditors that they have an interest in the property.

PMSI Blanket Filing
Gives a lender the right to repossess the collateral used to secure a loan A security interest in all of a customer’s assets
A PMSI can give lenders priority over other creditors if the borrower files for bankruptcy A blanket filing doesn’t give you priority over other creditors during bankruptcy
Gives the lender the right to repossess certain identifiable goods During bankruptcy, lenders are paid out depending on who filed first

A PMSI gives a lender the right to repossess collateral used to secure a loan or financial transaction. The UCC gives special benefits to lenders with a PMSI, and they’ll be given priority over other creditors during bankruptcy proceedings.

In comparison, a blanket filing covers all of a borrower’s assets. A blanket filing doesn’t give a lender priority over other creditors, and during bankruptcy, lenders are paid out based on when they filed a claim.

Key Takeaways

  • A PMSI gives a lender the right to repossess any collateral used to secure a loan or financial transaction.
  • A PMSI gives a lender priority over other creditors in bankruptcy proceedings.
  • A PMSI is often used in commercial lending and by retailers who sell goods on credit.
  • In order to be valid, most lenders are required to perfect the PMSI within 20 days of the borrower receiving the collateral.
  • In comparison, a blanket lien is a security interest in all of a customer’s assets, and won’t give the lender priority over other creditors.

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