Collateral is an asset that a borrower pledges as security for a loan. It is a borrowers pledge of specific property to a lender to secure repayment of a loan. The collateral serves as a lender's protection against a borrower's default and can be used to offset the loan if the borrower fails to pay the principal and interest satisfactorily under the terms of the lending agreement. Collateral can take the form of a physical asset, such as a car or home, or other valuable assets like cash, equipment, or real estate owned by a business.
The protection that collateral provides generally allows lenders to offer a lower interest rate on loans that have collateral. The reduction in interest rate can be up to several percentage points, depending on the type and value of the collateral. If a borrower defaults on a loan, the lender can seize the collateral and sell it to recoup the loss.
In summary, collateral is an item of value that a borrower pledges to a lender to secure a loan. It reduces the risk for lenders and allows them to offer lower interest rates. If a borrower defaults on the loan, the lender can seize the collateral and sell it to recoup its losses.
