Collateral is an asset a borrower pledges to secure a loan. If the borrower defaults, the lender can seize the asset and sell it to recover the debt. Collateral reduces the lender's risk, which is why secured loans often carry lower interest rates than unsecured loans. A mortgage is secured by the house. A car loan is secured by the car. A margin loan is secured by the securities in the brokerage account.

Not all assets make good collateral. Lenders prefer assets that are easy to value, easy to sell, and stable in price. Real estate, vehicles, cash, and marketable securities are common. Art, jewelry, and collectibles are less common because their value is subjective and the market is thin. Inventory and accounts receivable can be pledged for business loans, but lenders discount them because they can be hard to liquidate.

The loan-to-value ratio determines how much a lender will advance against collateral. A mortgage lender might lend 80 percent of a home's value. A car lender might lend 90 percent of a car's value. A securities lender might lend 50 percent of a stock's value. The haircut protects the lender if the asset's value falls.

Collateral can be repossessed if the borrower defaults. That is the legal right. It is also the borrower's risk. Pledging an asset you cannot afford to lose is a bad idea. Pledging an asset that might fall in value is risky too. The lender will demand more collateral or sell the asset if its value drops.