Definition
Collateral is an asset pledged by a borrower to secure a loan, which the lender can seize if the borrower fails to repay. It reduces lender risk and may allow borrowers to access better loan terms.
Why It Matters
Collateral plays a crucial role in credit markets. By providing security, it encourages lending and can reduce interest rates. Common forms of collateral include real estate, vehicles, inventory, or financial instruments. Without collateral, lenders may limit credit availability or charge higher rates to compensate for risk.
Example
When someone takes out a mortgage, the house itself typically serves as collateral. If the borrower defaults on payments, the lender can foreclose and sell the property to recover the loan.