subordinated debt
Debt that ranks below senior debt in priority of repayment in the event of bankruptcy, carrying higher risk and typically paying higher interest rates.
Example
“Mezzanine financing is subordinated debt — paid after senior lenders but before equity in bankruptcy.”
Memory Tip
SUBORDINATED debt = junior debt. Gets paid AFTER senior lenders. Higher risk, higher rate.
Why It Matters
Understanding subordinated debt helps you assess the true risk of any investment or loan you consider. If a company you invest in or lend to faces financial trouble, your money in subordinated debt will be repaid last, meaning you could lose your entire investment while senior creditors recover their funds.
Common Misconception
Many people assume that higher interest rates on subordinated debt automatically make it a good investment compared to regular bonds. In reality, the higher rate exists precisely because the risk is much greater, and you could lose everything if the borrower goes bankrupt, making the extra interest irrelevant if repayment never happens.
In Practice
A bank issues senior debt at 4 percent interest and subordinated debt at 8 percent interest. When the bank faces bankruptcy, senior creditors receive 90 percent of their money back first. Subordinated debt holders only get paid from whatever remains after senior debt is fully satisfied, potentially receiving nothing or only 10 percent of their investment back despite the attractive interest rate.
Etymology
SUBORDINATED (ranked lower, inferior) DEBT. DEBT that is SUBORDINATED (junior) to senior claims.
Common Misspellings
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See Also
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