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Collateral

Collateral is any asset pledged as a guarantee in a loan or line of credit.

Expanded Definition

Collateral is the primary way lenders reduce the risk of lending money, because it stands as surety for the balance of the loan. Should the lender not be repaid, the collateral would be confiscated as repayment for the loan. Therefore, the ideal collateral is worth more than the borrowed amount of money and isn't already pledged as collateral for any previous loan. The absence of collateral may mean that a loan is denied, that the borrower is subject to a higher interest rate, or that the loan requires a co-signer with approved collateral.

In a mortgage loan, for example, the home itself serves as the collateral, which is why homeowners typically can't borrow more than the home is appraised for. When homeowners fall behind or default on mortgage payments, as happened in unprecedented numbers in 2007 and 2008, the home is seized as repayment for the loan through what's known as foreclosure. The home also serves as collateral for home equity loans or lines of credit.

Other typical forms of collateral for personal loans include automobiles, jewelery, and investments. For example, already-owned securities stand as collateral when an investor borrows money from a broker to buy stocks on margin.

But collateral isn't limited to personal loans. Businesses seeking loans or lines of credit can use inventory, receivables, or equipment as collateral.

Loans backed by collateral are known as secured loans. Loans that have no collateral are called unsecured loans.

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