Collateral

Collateral refers to an asset, such as real estate, offered by a borrower to secure a loan from a lender. If the borrower fails to repay the loan as agreed, the lender can seize the collateral. Thus, collateral provides the lender with a form of security against the loaned capital.

The lender’s right to the borrower’s collateral is known as a ‘lien.’ To be considered secure, the value of the collateral must equal or exceed the remaining loan amount. Loans secured by collateral typically carry lower interest rates than unsecured loans because they pose less risk to lenders. Borrowers are incentivized to make payments to avoid losing their assets, and lenders have a means of recovering losses if necessary.

One common form of collateral is a mortgage. In this case, the borrower provides the property being purchased as collateral to the mortgage lender, usually a bank. If the borrower fails to make mortgage payments as agreed, the bank can initiate foreclosure proceedings, taking ownership of the property to sell and recover losses.

Note: In construction, a “collateral warranty” refers to an agreement related to a primary contract, extending a duty of care from one party to a third party not involved in the original contract. For further details, refer to collateral warranties.