Collateral is assets pledged as security against a loan, with real estate and vehicles being common examples. Other assets, such as jewelry and securities, can also be used. The borrower retains possession but agrees to repay the loan or risk losing the collateral.
The lending of funds often requires the designation of collateral by the recipient of the loan. Collateral is simply assets that the recipient has pledged as security against the value of the loan. In the event that circumstances make it impossible for the recipient to repay the loan, ownership of the collateral is transferred to the entity that issued the loan to settle the debt. Here is some information about the different types of assets that can be used as collateral in different situations.
One of the most common examples of a collateral loan is with real estate purchases. In many cases, the property purchased with the mortgage is held as collateral for the life of the loan. Essentially, the lending financial institution retains interest in the property until the homeowner pays off the mortgage in full. The mortgage holder must approve any change in ownership of the property as long as there is an outstanding balance on the loan. Once the debt obligation is released, the mortgage holder believes that the business agreement should be concluded and releases all claims to the property.
Similarly, many finance companies will use a newly purchased vehicle as collateral for the loan used to purchase the car. This gives the finance company the right to repossess the vehicle if the owner defaults on the loan for any reason. In general, companies that finance auto loans will only finance what is understood to be the current market value of the vehicle. This helps ensure that the collateral held on the property is sufficient to recover any losses that result from default.
Other assets can also be used as collateral in cash loans. For example, jewelry and securities that have certified value may be held as collateral until the loan is repaid. In some cases, rare antiques may be accepted as collateral. Depending on the circumstances, almost any asset clearly owned by an individual can be used as collateral, as long as the lending entity is willing to accept the asset as sufficient to guarantee the loan amount.
Providing collateral generally does not mean giving up possession of the asset that is used as collateral. However, the borrower agrees to retain control of the asset for as long as it is necessary to repay the loan. This helps provide the lender with a reasonable amount of confidence that the investment made in the borrower will be recovered, either through the systematic repayment of the loan or by taking possession of the collateral.
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