The term senior loan refers to debt that takes priority over junior or subordinate debt. Holders of senior loans are the first to be repaid in the event a company was to fail and its assets liquidated.
Also referred to as senior debt, senior loans are debt instruments that take priority over subordinate (junior) debt from the same issuer. Senior debt takes priority over all other forms of capitalization in the event of bankruptcy, meaning it must be repaid before all other creditors can receive payment. Senior debt also has priority with respect to payment and repayment. For example, holders of these securities are paid before the holders of common stock would receive a dividend payment.
While most senior loans are secured with collateral, it can also be unsecured. This complicates the repayment order in the event of liquidation. For example, while senior secured debt takes priority over subordinate secured debt, if the collateral securing the loan is sufficient to repay holders of secured subordinate debt, they will be repaid before holders of unsecured senior debt. This relationship is shown in the accompanying illustration.
As the risk of non-payment increases, so does the rate of interest on the security. For example, investors in unsecured subordinate debt would demand a higher rate of interest from the borrower than holders of secured senior debt.