Debt Dictionary


Investment Dictionary -> Collateral

Collateral stands for asset that are pledged by a loan recipient in order to guarantee the prompt repayment of a loan. The collateral functions to protect the lending institution against potential risks of default on the part of the borrower. In case that the recipient fails to repay the loan, under the specified terms and obligations, the lender becomes the owner of the property that is pledged as collateral. The most popular example of a collateral loan is the acquisition of a real estate property under the terms of a mortgage loan agreement. The mortgage serves as collateral for the entire duration of the loan repayment. Thus, if the borrower fails to repay the loan, the right over his property is transferred to the mortgage holder. In essence, the lender retains interest in the real estate until the loan is repaid in full. When the debt is discharged, the lending institution releases all claims over the property in question. Another common example involves the purchase of a vehicle by means of collateral. In principle, the lender will finance the current market value of the automobile.

Collaterals for secured loans serve to provide a certain degree of confidence that the lenders investment will be recouped. This will be materialized through repayment of the loan or via transfer of the assets ownership. Collaterals may be made in the form of accounts receivable, inventory such as raw materials, equipment and machinery, and personal assets. Jewelry and securities which posses a certified value may be held as collateral. In general, any asset that is owned by an individual may serve as collateral. This is valid if the lending institution agrees that the value of the asset is sufficient to guarantee the amount of the loan. Loans, granted by means of collateral, become secured debt. Again, default is followed by a transfer of property rights to the lending institution.

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