In lending agreements, collateral
is a borrower's asset that is forfeited
to the lender if the borrower is insolvent—that is, unable to pay back the principal and interest on the loan. When insolvent, the borrower is said to default
on the loan, in which case the lender becomes the owner of the collateral.
In a mortgage
, for instance, the real estate being acquired with the help of the loan serves as collateral. Should the buyer fail to pay mortgage interest, the ownership of the real estate is transferred to the bank in the process known as foreclosure
Concept of collateral
Collateral, especially within banking
, may traditionally refer to secured lending (also known as asset-based lending
) as well as more recently as collateralisation arrangements to secure trade transactions (also known as capital market collateralization
). The former often presents unilateral obligations, secured in the form of property
or other as collateral (originally denoted by the term security
), whereas the latter often presents bilateral obligations secured by more liquid assets such as cash
, often known as margin
. Another example might be to ask for collateral in exchange for holding something of value until it is returned (e.g., I'll hold onto your wallet while you borrow my cell phone).
In many developing countries, the use of collateral is the main way to secure bank financing. The ease of acquiring a loan depends on the ability to use assets, whether real estate or any other; as collateral.'''