What is collateral in the context of a loan?

Collateral refers to an asset that a borrower offers to a lender as security for a loan. It serves as a form of protection for the lender, as it can be seized and sold if the borrower fails to repay the loan as agreed. This mitigates the lender's risk, as having collateral increases the likelihood of loan recovery in case of default.

When the borrower pledges an asset—such as real estate, vehicles, or other valuable property—this agreement strengthens the lender's position. If the borrower becomes unable to make loan payments, the lender has the right to take possession of the collateral to recoup losses. Therefore, collateral is a crucial component in the lending process, providing a safety net for lenders and often allowing borrowers to secure larger loans or more favorable terms.