Collateral is an asset or property a borrower pledges to a lender as security for a loan or credit. It serves as a form of protection for the lender in case the borrower can't repay the loan as agreed. By providing collateral, the borrower offers an additional layer of assurance to the lender, reducing the lender's risk in extending credit.
The collateral can take various forms, such as real estate (e.g., a house or land), financial assets (e.g., stocks or bonds), valuable items (e.g., jewelry or valuable collectibles), or even cash deposits. The specific type of collateral depends on the type of loan and the lender's requirements.
If the borrower defaults on the loan, meaning they fail to repay it as agreed, the lender has the legal right to seize the collateral and sell it to recover the outstanding amount owed. The process of selling the collateral to recover the debt is known as foreclosure, repossession, or liquidation, depending on the type of collateral involved.
Collateral is common in various types of loans, including mortgages, auto loans, and business loans. The presence of collateral can offer advantages to borrowers, such as lower interest rates or a higher likelihood of approval for the loan, especially for individuals or businesses with less favorable credit histories.