# Understanding Purchase Money Security Interest (PMSI): Definition, Functionality

## What Is a Purchase Money Security Interest (PMSI)?

A purchase money security interest (PMSI) gives lenders payback priority in case of a loan default. Specifically, if the borrower defaults, a lender gets the right to repossess the property bought with the loan they made or to demand repayment in cash. The lender's claim is senior to those that may be made by other creditors. Lenders must file a UCC-1 financing statement to establish a PMSI.

### Key Takeaways

*   A PMSI grants creditors a secured interest in the property they financed, giving them priority over other creditors in the event of a debtor default.
*   There are strict regulatory requirements for establishing a PMSI, including filing a UCC-1 financing statement, which helps communicate the creditor's secured interest in the financed collateral.
*   PMSIs are commonly used in both consumer credit and business transactions, including point-of-sale financing and B2B transactions, to secure goods sold on credit.
*   Specific rules govern PMSI claims for inventory and non-inventory collateral, emphasizing the importance of perfection and proper notification to other potential secured parties.
*   PMSI can supersede existing claims, such as blanket liens, if statutory conditions are met, providing significant leverage to creditors in collection scenarios.

## How Purchase Money Security Interest Works

[Lenders](https://www.investopedia.com/terms/l/lender.asp) have several options to protect their financial interests if [debtors](https://www.investopedia.com/terms/d/debtor.asp) fail to live up to their financial obligations. Financial firms can pursue consumers who miss payments by sending them to collections, suing, enforcing [liens](https://www.investopedia.com/terms/l/lien.asp), or using PMSIs. The PMSI gives a specific lender a right to [property](https://www.investopedia.com/terms/p/property.asp) or its full cash value before any other creditor—as long as that lender's money was used to finance the purchase.

Some lenders, [credit card](https://www.investopedia.com/terms/c/creditcard.asp) companies, and retailers use PMSIs when offering financing options. A PMSI effectively gives them collateral to confiscate if a borrower defaults on payment for a large purchase. It also is used in [business-to-business (B2B)](https://www.investopedia.com/terms/b/btob.asp) transactions. The option of obtaining a PMSI encourages companies to increase sales by directly financing new equipment or inventory purchases.

A purchase money security interest is valid in most jurisdictions once the buyer agrees to it in writing and the lender files a financing statement. [Article 9](https://www.investopedia.com/terms/a/article-9.asp) of the [Uniform Commercial Code (UCC)](https://www.investopedia.com/terms/u/uniform-commercial-code.asp) outlines this procedure, a standard in most states.

These rules help businesses operate across state lines more easily. Article 9 is the section of the code that outlines the treatment of secured transactions including how [security interests](https://www.investopedia.com/terms/s/security-interest.asp) are created and enforced.

PMSI protection has helped grow [point-of-sale](https://www.investopedia.com/terms/p/point-of-sale.asp) financing, where retailers offer direct loans for big purchases. If the buyer defaults, the retailer can repossess the items before other creditors.

> **Important**
>
> The procedures permitting enforcement of a PMSI are strict and outlined in the Uniform Commercial Code (UCC).

## Key Rules for Purchase Money Security Interest

PMSI rules differ based on the type of collateral bought with loan money. Generally, the first creditor to file a financing statement or "[perfect](https://www.investopedia.com/terms/p/perfected-lien.asp)" a security interest gets the PMSI.

Below are the specific rules for inventory and non-inventory collateral, although there are specific rules for other types of goods as well.

### Understanding PMSI for Inventory Collateral

Section 9-324(b) outlines the rules to perfect PMSI in [inventory](https://www.investopedia.com/terms/i/inventory.asp). First, the PMSI must be perfected when the borrower takes possession of the inventory. Second, the secured party must provide notification to conflicting security holders before perfection. Third, the secured party must notify other security holders that it expects to acquire a PMSI in the borrower's inventory.

To perfect a PMSI in inventory, the secured party must file a [UCC-1](https://www.investopedia.com/terms/u/ucc-1-statement.asp) that identifies the goods sold as [collateral](https://www.investopedia.com/terms/c/collateral.asp). This filing provides notice to other interested parties that the secured party is in the process of obtaining a PMSI on the borrower's personal property. In addition, the written notice delivered to other security notices must be distributed no more than five years before the borrower receives inventory.

### How to Apply PMSI to Non-Inventory Collateral

The rules for securing a PMSI for non-inventory collateral are often less rigid. The secured party must be able to demonstrate that the credit they extended to the borrower was used to purchase the collateral. The secured party must also file a financing statement covering the collateral within 20 days of the borrower receiving possession of the collateral.

Similar to inventory PMSIs, a secured party must file a UCC-1 to perfect a PMSI for non-inventory collateral. This must be filed before the borrower takes possession of the collateral or within the first 20 days of possession. If the filing takes place after these 20 days, the secured party won't have PMSI priority and will be prioritized after other perfected security interests.

> **Tip**
>
> The financing statement for non-inventory collateral can be pre-filed before the borrower takes possession of the goods. In addition, keep copies of every delivery document, as a PMSI claim may be vulnerable to disqualification if the date of possession is in question.

## How Sellers Can Establish a Security Interest

At the core of PMSI, the party attempting to gain the secured interest must demonstrate that the credit they extended was used to acquire the collateral. For this reason, a company may want to intentionally structure an order of payments or series of contracts for goods not yet manufactured.

For example, if a consumer arranged to buy a custom-made sofa on credit from a furniture retailer, the retailer would put through an order with the manufacturer and pay for the sofa before finalizing the [financing](https://www.investopedia.com/terms/f/financing.asp) agreement. In this case, the retailer is the owner selling the sofa—not the manufacturer. In legal terms, the retailer has a security interest in the property just sold and can obtain and enforce a PMSI.

For the same reason, if the buyer puts down a [security deposit](https://www.investopedia.com/terms/s/security-deposit.asp) on the sofa, the retailer may insist that the buyer pays for it in full before the security deposit is returned. This establishes the full dollar value that the lender is entitled to demand in case of default. Court rulings regarding PMSI claims have established the lender's right to demand [reimbursement](https://www.investopedia.com/terms/r/reimbursement.asp) of other costs related to the purchase, such as freight charges and sales taxes.

## How Do I Get a Purchase Money Security Interest (PMSI)?

A PMSI is obtained when a creditor lends money to a borrower and the borrower uses that money to buy goods. In return, the borrower grants the creditor a security interest in those goods should they default on their loan. Different types of collateral or goods have different rules, but the broadest requirements state the secured party must file a UCC-1 to publicly communicate their intention to gain a secured interest in a good. The secured party also may be required to notify other potential secured parties.  

## What Is a Purchase Money Security Interest Under the UCC?

A PMSI under the Uniform Commercial Code is an exception to the first-in-time creditor prioritization rule. The UCC states that creditor priority for secured interests is often dictated by who was the first secured creditor (or the timing of when their interest occurred). The PMSI exception allows for creditors who may not be first to still secure an interest in collateral, should they meet filing requirements.

## Does a Purchase Money Security Interest Trump a Blanket Lien?

Yes, a PMSI can receive priority status over a previously perfected [blanket lien](https://www.investopedia.com/terms/b/blanketlien.asp). The PMSI must have been perfected within statutory requirements. For example, the PMSI receives priority status only if it is filed before or within the first 20 days of the borrower's possession of the goods.

## What Is an Example of a PMSI?

A car loan can be an example of a PMSI situation. A financial institution may agree to lend money to a borrower to finance the purchase of a new car. The bank can register its interest in the car as a PMSI because the loan funds are being directly used to buy the property it wants a secured interest in.

## The Bottom Line

A PMSI gives a lender the legal right to repossess goods or demand cash repayment if a borrower defaults on the lender's loan. It also gives the lender's claim priority over those of other creditors. The lender maintains a security interest in the collateral purchased using the loan until the goods are completely paid for. Other creditors/sellers can obtain a secured interest in their loans' collateral by following specific regulatory rules, which include filing a UCC-1 financing statement.

> **Article Sources**
>
> 1.  Walters Kluwer. "[What Is a Purchase Money Security Interest?](https://www.wolterskluwer.com/en/expert-insights/what-is-a-purchase-money-security-interest)"
>     
> 2.  Cornell Law School. "[9-324. Priority of Purchase-Money Security Interests](https://www.law.cornell.edu/ucc/9/9-324)."