Collateral - Financial definition
Concise definition of the term collateral
The term collateral describes assets pledged by a borrower to secure payment of a loan or bond issue in the event of default. If the borrower defaults, the lender has the legal right to seize the collateral and sell it to pay off the loan.
Comprehensive definition of the term collateral
In the broader context of finance, collateral is used in various types of lending arrangements, including mortgages, auto loans, and business loans. Common forms of collateral include real estate, vehicles, stocks, bonds, and other tangible assets. For example, in a mortgage, the property being purchased serves as the collateral for the loan.
Collateral reduces the risk for lenders, allowing them to offer loans at lower interest rates and to borrowers with varying credit profiles. In securities lending and repurchase agreements, collateral is used to secure transactions between financial institutions, ensuring that obligations are met even if one party defaults. The use of collateral is a fundamental practice in both consumer and commercial lending, underpinning many aspects of the financial system by providing security and confidence to lenders.