Every investor wants their invested money to be safe and also get good returns. When it comes to investing in bonds, the most important thing is to understand which bond is right for you. There are two types of bonds available in the market – secured bonds and unsecured bonds. There is a big difference between the two: in one your money is backed by an asset, while in the other the risk is higher.
In this blog, we will give complete information about secured vs unsecured bonds in simple and clear language, so that you can invest wisely.
What Are Bonds and Why Do Companies Issue Them?
A bond is a debt instrument through which a company or government borrows money from the investors or general public and promises to pay fixed interest payments in return. After the completion of the certain period, i.e., at maturity, the investor gets his principal amount back. Bonds are also called fixed income products because the returns in them are pre-determined.
Why do Companies and Governments issue Bonds?
Companies and governments prefer to raise funds through bonds instead of taking a loan from the bank, because this gives them access to capital at a lower interest rate and for a longer period. Also, through bonds they can meet their financial needs without giving up any equity stake.
What is the role of creditworthiness and collateral?
The safety of a bond largely depends on the creditworthiness of the issuing institution. While some bonds are backed by collateral, others rely solely on the issuer’s promise to repay. The former are known as secured bonds, where pledged assets act as a safety net for investors in case of default. The latter are unsecured bonds, which carry higher risk since they offer no such asset-backed protection and depend entirely on the issuer’s ability to repay.
If you have ever bought bonds from any other platform, you must have seen words like “secured” or “AAA-rated”. But these words sometimes seem like mere technical information until you understand their real significance. Let us learn about secured and unsecured bonds in detail.
Read Also: What Are Corporate Bonds?
What Are Secured Bonds?
Secured bonds are bonds that are secured by an asset or collateral. This means that if the company issuing the bond defaults, investors have the right to claim the collateral. The collateral can be in the form of property, machinery, inventory, or any other asset.
These bonds are less risky because even if the issuer is not trustworthy, there is still a possibility of recovery of investor money from the asset. This is why their interest rate on secured bonds is often slightly lower than unsecured bonds, but the security is higher.
Example : Suppose a real estate developer issues secured bonds to fund the construction of a new commercial complex. These bonds are backed by the land and the under-construction property itself. This means that if the developer fails to repay, investors can recover their money through the sale or ownership of the pledged property, offering a strong layer of protection.
These types of secured bonds are linked to stable revenue sources or assets, giving investors the assurance of a guaranteed return on their invested money even if the issuing agency runs out of funds for some reason.
Secured Bonds are ideal for people who want to take less risk such as:
- Retired individuals
- Senior citizens
- Investors who prefer capital protection
- People who want a stable and secure income in their portfolio
So, if you are risk averse and looking for a stable income, secured bonds can be a suitable option for you.
Read Also: What is Coupon Bond?
What are Unsecured Bonds?
Unsecured bonds are bonds that do not have any collateral. This means that if the company issuing the bond defaults, investors have no claim over any assets of the issuing company to recover their money. Investing in these bonds depends entirely on the creditworthiness and financial strength of the company. These bonds usually offer higher interest rates than secured bonds to compensate investors for higher risk.
Example : Suppose an NBFC (Non-Banking Financial Company) issues unsecured bonds or debentures to raise funds for its expansion. These bonds are issued without backing from any specific assets, meaning investors rely solely on the company’s creditworthiness and track record for repayment. If the company incurs losses or goes bankrupt in the future, these investors will get repaid only after the secured bond holders and other primary creditors have been paid.
Unsecured bonds are better for investors:
- Who are willing to take a little more risk
- Who have experience in analyzing the company’s credit rating and financials
- Who can accept the potential risk to capital in exchange for higher returns
If you want to invest in such bonds, then give preference to AAA or AA rated issuers and stay away from high-yield bonds without proper research. Investing without proper research can cause significant losses, especially if the issuer has a weak financial position.
Secured vs Unsecured Bonds: Key Differences
| Feature | Secured Bonds | Unsecured Bonds |
|---|---|---|
| Collateral | Backed by specific assets or property (e.g., land, equipment) | No collateral; based solely on issuer’s creditworthiness |
| Risk Level | Lower risk as it is an asset-backed security | Higher risk as repayment depends entirely on the issuer’s financial strength |
| Interest Rate | Generally lower, as the bond is considered safer | Typically higher to compensate for the increased credit risk |
| Repayment Priority | Paid before unsecured creditors in case of default | Paid after claims of all secured creditors are settled |
| Issuer Type | Often issued by infrastructure firms, public sector companies, or asset-heavy companies | Frequently issued by corporates, NBFCs, or private firms with good credit ratings |
| Credit Ratings Impact | Ratings depend on both asset value and issuer profile | Ratings rely primarily on the issuer’s profile and repayment track record |
| Investor Suitability | Suitable for conservative investors prioritizing capital protection | Suitable for experienced investors seeking higher returns with moderate to high risk |
Read Also: What are Bond Yields?
Risk & Return Trade-Off: Which One Should You Choose?
The most important question while investing in bonds is to choose safety or higher returns?
How much is the risk?
Secured bonds have low risk because they are secured by an asset. If the issuer defaults, the investor can claim the asset. Hence, they are considered suitable for retired people or those who want a secure income. On the other hand, unsecured bonds do not have any security. If the issuer fails to make payments, investors of the unsecured bonds are repaid after secured bondholders are paid, making unsecured bonds a risky investment.
How much is the return?
Secured bonds have relatively low interest rates (e.g. 7–8%), as there is more security. In contrast, unsecured bonds offer higher returns (e.g. 9–11%), but with risk.
Which is right for whom?
If your focus is on capital safety, then secured bonds are a better option. However, if you are seeking higher income, can tolerate greater risk, and are capable of assessing a company’s credibility, unsecured bonds can also be a good option. Always ensure you check the credit rating before investing.
Read Also: Electoral Bonds Explained: What Are They and Why Did Supreme Court Ban It?
Conclusion
It is very important for an investor to understand the difference between secured bonds and unsecured bonds. While secured bonds offer more security, unsecured bonds may offer a slightly higher return but also carry risk. Secured vs unsecured bonds should be carefully weighed while planning your investment strategy to get the right balance between risk and return. It is important to consult a financial advisor before investing.
Frequently Asked Questions (FAQs)
What is the main difference between secured and unsecured bonds?
Secured bonds are backed by an asset, while unsecured bonds do not have any such collateral.
Are secured bonds safer than unsecured bonds?
Yes, secured bonds are considered safer because repayment is guaranteed by an asset.
Do unsecured bonds offer higher returns?
Mostly yes, because the risk is higher in these, so the interest rate is also slightly higher.
Can individual investors buy secured bonds in India?
Yes, many government and corporate secured bonds are available for individual investors.
Which type of bond is better for beginners?
Secured bonds are better for beginner investors as they have lower risk.
