In the world of finance, collateral is a type of asset that a borrower pledges as part of a loan agreement. Should the borrower stop repaying and default on the loan, the collateral pledged can be seized by the lender as part of the agreement.
Usually, the collateral takes the form of property, real estate, or vehicle although other forms of collateral exist. Pawnshops, for example, accept a wide variety of items as collateral in exchange for a loan. This can be physical gold and jewelry, electronics, and even collectibles.
Loans with collateral as a condition typically have lower interest rates, as the risk is reduced on the lender’s side. Collateral can provide a few points discount on a lending rate.
Not every loan requires collateral, however. It depends usually on the size of the loan, the borrowers’ credit score, and the terms of the loan. If a borrower has good credit, the loan is small in scope, and the terms are favorable, collateral may not be required.
In the world of mortgage lending, usually, the lender or mortgage provider can place a lien on the property if the terms of the mortgage aren’t fulfilled. Essentially this means if the borrower defaults on the loan and doesn’t pay it back, the home can be seized by the mortgage provider or lender.
Collateral is also common in the world of auto loans & car financing. Like mortgages, usually, the lender can establish a lien on the vehicle in cases where the borrower ceases to pay repayments.