Collateral
An asset a borrower pledges to secure a loan, which the lender can take and sell if the borrower fails to repay.
What it means
Collateral reduces a lender’s risk, so loans backed by it usually have lower rates or easier approval. Common examples are a home for a mortgage, a car for an auto loan, a cash deposit for a secured credit card, and savings or a CD for a share-secured loan.
If the borrower defaults, the lender can foreclose, repossess or claim the deposit, following the legal process for that type of asset, which varies by state. If selling the collateral does not cover the debt, the borrower may still owe the remaining amount, depending on the loan and state law.
Example
For example, a credit union might offer a $5,000 loan secured by a $5,000 certificate of deposit. The CD stays frozen until the loan is repaid, and the lender can apply it to the balance if payments stop.
How it’s used
- Getting a lower rate on a loan
- Building or rebuilding credit with a secured product
- Understanding what is at stake before borrowing
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.