Definition of Collateral

Individuals that borrow money may opt for secured loans through the use of collaterals. But what is meant by collateral? Collateral means something the borrower guarantee to the lender to make safe the loan for the benefit of the security of the loan and for lessening the risk of the lender. Collaterals may include any type of property, vehicle, and evidence of deposits such as stocks or bonds.

Collaterals provide as assertion on the part of the lender, that can serve as back up or payment for the loan financed in case the loan is not repaid. In other words, collateral is a term used for assets that a borrower is obliged to turn over to a lender if unable to repay a loan. Usually, the property itself is the collateral for a property loan. Collateral recovers all or part of a debt, if repayment of the loan is not forthcoming.

The principal security is usually the borrower's personal guaranty, or the cash flow of a business. Except for highly creditworthy customers who can get loans against only their signatures, lenders always demand a collateral if the primary security is not considered to be reliable or sufficient enough to recover the loan in case of a default. A lien is formed when the collateral is registered in the public records office, giving the registered lender priority over other lenders on the same asset or property. Lenders have the legal right to seize and sell collateral if the borrower cannot pay back the loan as agreed. Sometimes the asset being financed such as accounts receivable, inventory, machinery is itself used as collateral. In home mortgages the property being bought serves as collateral.