Bonds are issued as either unsecured or secured to bond receivers, depending on the situation at hand. Unsecured bond issues, also referred to as debentures, are a form of lending for which the bond receiver has no collateral to pay off the bond; in such case a default occurs. Unsecured bonds are not backed by mortgages on any type of real estate, revenue, or machinery and are given to the receiving person or party, when a “Full Faith and Credit” has been established to the organization issuing the bond.
Unsecured bonds are typically only issued for a corporation that has already been established, and when some history of good credit has been demonstrated by the receiving company. Most of the time, when an unsecured bond is issued to a company that does not have enough assets to collateralize, then the debenture will pay a fixed higher interest rate on the bond debt. When the federal government issues unsecured bonds to states or municipalities, if that local or state government fails to repay the bond debt, then the federal government just raises taxes until the bond is repaid.
Secured bonds are bonds that are backed by real estate mortgages, machinery, revenue, or any asset that is collateralized within a company. Secured bonds are much more likely to be a safer means of issuing a bond to a company, municipality, or state government. Many secured bonds are used for the construction of government projects such as bridges, toll ways, railroad, or airports to name a few larger government bonded projects. The revenue that is projected to be accumulated from those projects is usually what is securing the bond.
Another feature of secured bonds is they are typically a safe and assured method, especially in real estate mortgages. Mortgage bonds or first mortgage bonds and junior mortgage bonds collateral is found in the assets within a company in they event of foreclosure and if they have to collateralize their assets for liquidation. First mortgage bonds are to be the first paid off, if foreclosure occurs. Companies that do not foreclose on the bond debt use the land and any expected profits from the project on the land as their collateral. These types of secure bonds are safe and usually a low interest, high yield, type of bond and is positive for the bondholders and debentures alike.
The unsecured bond versus secure bond comparison can be drawn down to what is best for the bondholder and the debentures alike. Bonds are used to promote the growth of capitalist countries by ensuring both parties do not fail because of bonds.