Collateral

Financial Dictionary -> Loans -> Collateral

Collateral is a form of security for a loan and is sometimes simply known as a secured loan. A lender may require collateral before allowing a borrower the loaned money, to ensure they have a safer and better chance of being paid back. The borrower must sign over assets (whether it is a house or other item) - This is known as the collateral and if they fail to make the loan repayment, the house (or whatever asset was agreed as collateral) can be seized by the lender to legally cover what they are owed. The lender may keep the asset if it is likely to go up in value or just sell it right away to make back the unpaid capital.

Collateral is used in all sorts of different loan situations. For example a bail bond agent may require collateral to cover the costs if a defendant skips bail. The most common use for collateral loans is for people with bad credit, who want a personal loan and it is also common in certain business where real estate or shares are offered as collateral. A person with bad credit is more likely to get a loan with collateral because the asset is already predetermined, so no matter what the lender will be repaid somehow.

Real estate is probably the most common asset used in collateral because it generally increases in value, but if an asset is pledged that decreases in value it is still the borrower's responsibility to make the rest of the payment if the asset no longer covers it. If this is a problem the lender may take the borrower to court and force bankruptcy so other assets can be put into liquidation and sold to make the repayment.

If a scenario happens where a house is used as collateral but only a portion of its value is needed, then the lender can still force the sale of the house but the borrower gets his fair share. E.g. John's house is worth $150,000 and he used it as collateral, yet he only owes $50,000 - then a sale would go ahead but John would keep $100,000.