Collateral (finance)

In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.^[1][2] The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation. If a borrower does default on a loan (due to insolvency or other event), that borrower forfeits (gives up) the property pledged as collateral - and the lender then becomes the owner of the collateral. In a typical mortgage loan transaction, for instance, the real estate being acquired with the help of the loan serves as collateral. Should the buyer fail to pay the loan under the mortgage loan agreement, the ownership of the real estate is transferred to the bank. The bank uses a legal process called foreclosure to obtain real estate from a borrower who defaults on a mortgage loan obligation.

Concept of collateral

Collateral, especially within banking, may traditionally refer to secured lending (also known as asset-based lending). More recently, complex collateralisation arrangements are used to secure trade transactions (also known as capital market collateralization). The former often presents unilateral obligations, secured in the form of property, surety, guarantee or other as collateral (originally denoted by the term security), whereas the latter often presents bilateral obligations secured by more liquid assets such as cash or securities, often known as margin. Another example might be to ask for collateral in exchange for holding something of value until it is returned. Some forms of lending are solely based on the strength of the collateral such as gold jewelry and property. Certain non-conservative lending practices such as lending against antique items or art works are also known to exist.

In many developing countries, the use of collateral is the main way to secure bank financing.^{[citation needed]} The ease of acquiring a loan depends on the ability to use assets such as real estate as collateral.

See also

• Consignment
• Security interest
• Credit risk
• Hypothecation
• Cross-collateralization

References

1. ^ Garrett, Joan F. (1995). Banks and Their Customers. Dobbs Ferry, NY: Oceana Publications. p. 99. ISBN 0379111942. http://books.google.com/books?id=h3YFAAAACAAJ&dq. 
2. ^ Sullivan, arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 513. ISBN 0-13-063085-3. http://www.pearsonschool.com/index.cfm?locator=PSZ3R9&PMDbSiteId=2781&PMDbSolutionId=6724&PMDbCategoryId=&PMDbProgramId=12881&level=4.