Collateral
Quick Answer
Collateral is an asset pledged by a borrower to secure a loan, which the lender can seize if the borrower fails to repay.
Definition
Collateral is an asset pledged by a borrower to secure a loan, which the lender can seize if the borrower fails to repay.
Explanation
Collateral reduces the lender's risk by providing a backup source of repayment. Common types of collateral include real estate (for mortgages), vehicles (for auto loans), inventory or accounts receivable (for business loans), and cash deposits (for secured credit cards).
Loans secured by collateral typically have lower interest rates than unsecured loans because the lender faces less risk. The value of the collateral is assessed by the lender, and the loan amount is usually a percentage of the collateral's appraised value, known as the loan-to-value ratio.
Example
A business pledges $100,000 in accounts receivable as collateral for a $70,000 working capital loan. If the business defaults, the lender can claim the receivables to recover the loan amount.
Frequently Asked Questions
What is Collateral?
Collateral is an asset pledged by a borrower to secure a loan, which the lender can seize if the borrower fails to repay.
How does Collateral work?
Collateral reduces the lender's risk by providing a backup source of repayment. Common types of collateral include real estate (for mortgages), vehicles (for auto loans), inventory or accounts receivable (for business loans), and cash deposits (for secured credit cards).Loans secured by collateral typically have lower interest rates than unsecured loans because the lender faces less risk. The value of the collateral is assessed by the lender, and the loan amount is usually a percentage of the collateral's appraised value, known as the loan-to-value ratio.
Can you give an example of Collateral?
A business pledges $100,000 in accounts receivable as collateral for a $70,000 working capital loan. If the business defaults, the lender can claim the receivables to recover the loan amount.