What Is Collateral?

Finance
#1

Collateral is a term used to describe an asset that a lender accepts as security for a loan. Depending on the purpose of the loan, collateral might be real estate or other types of assets. For the lender, the collateral serves as a sort of insurance. If the borrower defaults on their loan payments, the lender can seize and sell the collateral to recuperate part or all of their losses.

#2

Collateral is an item that is effectively held hostage by the creditor (person lending money) as guarantee that the debtor (the person who borrowed money) will repay the loan.

If I am loaning you $300 for a week until your pay-check comes in, I might ask to hold something I know you value as collateral. If I am not a friend of yours, and this is a business transaction, the item I ask for should be sellable for about the amount of money I lent you (or more).

For larger loans, often the thing you are buying serves as collateral for the loan – if you cannot keep making your payments, the bank gets to take the car/house/whatever that you originally took out the loan to help you buy.