What is Junior Debt?

There are different types and levels of debt that a company can issue, and therefore debt investors are treated with various levels of priority. Junior debt, also known as subordinate debt, carries less priority than senior forms of debt. This is because junior debt typically is not backed by any collateral and is unsecured in relation to higher debt forms. Junior debt is considered more risky than senior debt, which typically has some asset tied to the loans and gives investors some assurance that they will be compensated.

Consumers also take on various forms of debt, including senior debt and junior debt. A mortgage loan or a car loan are senior forms of debt because they are collateralized, or tied to a tangible item such as a piece of real estate or a vehicle. Junior debt would be a loan that is not tied to any physical item, and it might include credit card loans. If an individual defaults on a loan agreement, the mortgage issuer and car loan issuer can both take those items back, but a credit card issuer must wait for a court to decide whether they will be paid and how.

In corporate financing, the type of debt that a company is obligated to depends on its financial structure. A company issues certain types of debt or bonds in the debt capital markets based on its financial status and history for repaying loans. Once debt is issued, bondholders become entitled to subsequent payments after purchasing that debt from the company. The debt issuer, the company, becomes responsible for distributing principal payments to investors on a regular basis for the term of the bond. A company must prioritize payments based on the type of debt that is carried on its balance sheet and ideally will honor all debt obligations.

In the event that a company is forced into bankruptcy or voluntarily decides to file for bankruptcy, debt holders have certain rights to that company's assets. A junior debt holder carries the least amount of claim to those assets and will be paid only if there is anything else left after senior debt holders are reimbursed. These senior debt holders might include creditors such as suppliers and secured bond holders. A secured loan is one that is backed by some collateral that the investor is entitled to if a company fails to make interest payments. Once the asset is received, the investor is then able to liquidate or sell it for a profit.

Junior debt might be subordinate merely in relation to the type of debt that a company has on its books. For instance, a holder of junior debt takes less priority than the holder of a bond that is secured by a mortgage. This same junior debt holder takes priority over preferred equity holders who are similarly entitled to ongoing dividend payments.