Collateral

Collateral is an asset pledged by a borrower to secure a loan or obligation. If the borrower fails to meet payments, the lender has a secured claim on the collateral, which can be seized or sold to recover losses. Collateral reduces credit risk and can enable better loan terms, such as lower interest rates or higher credit limits.

Common forms include real estate (mortgages), motor vehicles (vehicle loans), and equipment; financial assets like securities, accounts receivable, inventory, or cash deposits; also intangible assets such as patents or trademarks in some cases. In consumer credit, collateral is most visible in mortgages and auto loans; in corporate finance, collateral often includes receivables or inventory.

A security interest is created by a security agreement between borrower and lender, often accompanied by a filing or possession requirement to perfect the interest. Perfection makes the lien enforceable against third parties; the priority among competing claims is typically determined by the timing of perfection and by statutory rules.

Upon default, the lender may seize or take control of the collateral and sell it to satisfy the debt. Proceeds are applied first to costs, then to the debt, with any surplus returned to the borrower if allowed by law. The process is governed by contract terms and applicable law, which varies by jurisdiction.

Valuation affects loan size; collateral should have sufficient liquidation value and be insured. The sale method, market conditions, and legal rights (redemption, exemptions) influence outcomes. Borrowers bear the risk that collateral loses value or is insufficient to cover the debt. Lenders manage risk via diversification, lending limits, and intercreditor arrangements.

Legal frameworks vary; in the United States, secured transactions are largely governed by Article 9 of the Uniform Commercial Code. In other jurisdictions, different statutes govern creation, perfection, and enforcement of security interests.