Definition
Collateral consists of any type of property that is pledged to a lender to guarantee a loan.
Analysis
There are different situations in which a lender may require the use of collateral to guarantee a loan or line of credit. These include:
- A secured loan, such as a car loan or mortgage loan in which the purchased item serves as collateral for the loan
- A personal loan may sometimes require a Certificate of Deposit or other consideration to guarantee the loan
- A secured credit card requires a cash deposit that protects the lender in case the borrower defaults on the debt account
- A payday loan will require a postdated check as a form of virtual collateral, with the expectation that funds will be available in the account at a later date in order to honor the loan
- A title loan generally requires the title to a vehicle to secure a loan
Collateral can serve to lower the loan costs in many cases. Lenders may be willing to lower the interest rate substantially when they have a security interest in the property that serves as collateral.
Failure to honor a loan agreement can result in loss of the collateral by the consumer. The lender may foreclose on a home, or repossess an automobile used to secure the loan. A security deposit may be claimed by the lender if a cardholder defaults on a secured credit card.
