Collateral is an asset pledged to secure a loan. If the borrower fails to repay, the lender can seize the asset and sell it to recover the money. A mortgage uses the house as collateral. A car loan uses the car. A business loan might use equipment, inventory, or receivables. Collateral reduces risk for the lender, which often lowers the interest rate for the borrower.

Not all assets work equally well as collateral. Lenders prefer assets that are easy to value, easy to sell, and stable in price. Real estate, vehicles, and publicly traded securities qualify. Art, jewelry, and specialized equipment are less attractive because their markets are thin. A loan against such assets may come with a higher rate or a lower loan-to-value ratio.

When a borrower defaults, the lender seizes the collateral. If the sale brings less than the loan balance, the borrower may still owe the difference. If it brings more, the borrower may receive the surplus. The process varies by jurisdiction and loan agreement. Collateral is not a guarantee of repayment. It is a backstop. For unsecured loans like credit cards, no collateral exists. That is why their interest rates are much higher.

Common types

• Real estate
• Vehicles
• Securities
• Equipment and inventory
• Cash and savings