In
lending agreements,
collateral is a
borrower's pledge of specific
property to a
lender, to
secure repayment of a loan.
The collateral serves as protection for a lender against a borrower's
risk of
default - that is, any borrower failing to pay the
principal and
interest under the terms of a loan obligation. If a borrower does default on a loan (due to
insolvency or other event), that borrower forfeits (gives up) the property pledged as collateral - and the lender then becomes the owner of the collateral. In a typical
mortgage loan transaction, for instance, the
real estate being acquired with the help of the loan serves as collateral. Should the buyer fail to pay the loan under the mortgage loan agreement, the ownership of the real estate is transferred to the
bank. The bank uses a
legal process called
foreclosure to obtain real estate from a borrower who defaults on a mortgage loan obligation.
Concept of collateral
Collateral, especially within
banking, may traditionally refer to
secured lending (also known as
asset-based lending). More recently, complex collateralisation arrangements are used to secure trade transactions (also known as
capital market collateralization). The former often presents unilateral obligations, secured in the form of
property,
surety,
guarantee 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 or
securities, 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.'''
See also
