Definition Definition

What Is Collateral? Understanding Collateral with Example

What is Collateral?

Collateral is an asset (such as a vehicle) pledged to a lender until a loan is repaid. If the borrower defaults, the lender has the legal right to seize the collateral and sell it to pay off the loan. Comprehensive and Collision coverages are required by lenders when a car is collateral for a loan.

Definition 2

Collateral is a borrower’s possession of adequate net worth, quality assets, or other items of value that support his or her ability to repay a loan.

Definition 3

Collateral is the property that is pledged to the lender to guarantee payment in the event that the borrower is unable to make debt payments.

More Thorough Understanding of the Term

Any asset that a borrower guarantees to a lender to obtain a loan is referred to as collateral in finance. If the borrower fails on the loan, the lender can sell this asset.

Collateral protects the lender against the risk of default, and it helps to minimize the borrower's cost of borrowing. Collateral is utilized in many different types of loans, including mortgages, auto loans, and business loans.

The usage of collateral does not come without risks. If the borrower fails on the loan, the lender may take and sell the collateral to recoup their losses. However, in some situations, the collateral value may not be adequate to cover the entire loan amount. This can result in a loss for the lender, and the borrower may still be obligated to repay the entire loan balance.

Example of Collateral

Collateral protects the lender and lowers the risk of default. Even if the borrower defaults on the loan, the collateral serves as an assurance to the lender that they will receive their money back. The collateral value is usually equal to or greater than the loan value. 

For example, if a borrower wishes to obtain a $10,000 loan, he or she may be required to produce collateral worth $10,000 or more. Cash, property, or other assets can be used as collateral.

In Sentences

  • Collateral minimizes the danger of default; it serves to lower the interest rates offered by lenders.
  • Borrowers can also receive loans more easily when collateral is used.
Share it: CITE

Related Definitions

  • Collateral damage
    Collateral damage refers to unintentional or incidental injury or damage...