Collaterals

What are collaterals?

Collaterals are assets that a borrower provides to a lender (or creditor) as security in order to obtain financing.

What is the concept of collateral?

Collateral is defined as a valuable asset provided by the borrower to the lender to serve as security for the loan. One of the most common examples is when a person applies for a mortgage from a bank to purchase a home, the home is used as collateral for the loan. In the case of an auto loan, the car is used as collateral. Companies that obtain financing from banks can pledge valuable equipment or real estate they own as collateral for the loan.

In the event of failure to repay, the lender has the right to seize and sell the collateral, and to use the proceeds to repay the outstanding portion of the loan. The lender also has the right to take the necessary legal action against the borrower to recover any remaining balance.

Examples of secured loans

There are many forms of secured borrowing, and the most well-known is the mortgage, in which the home serves as collateral. If the borrower, that is, the homebuyer, defaults on payments for a period determined by the bank, legal proceedings are initiated against the borrower, culminating in the repossession of the home. Another example is a Home Equity Loans, in which the home owned by the borrower is appraised, and the loan is then granted on the condition that the loan amount does not exceed the appraised value of the home. Another example is margin trading, which is a form of secured borrowing, where an investor borrows money from a broker to purchase stocks, using the balance in their brokerage account as collateral.

Related term: "unsecured loans" are loans that do not require collateral, such as personal loans or credit cards.

Compliance disclaimer

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