Legal Definitions - collateral

Collateral is something valuable that a borrower pledges to a lender to guarantee a loan. If the borrower fails to repay the loan, the lender can take possession of the collateral and sell it to recover the money owed. The value of the collateral is usually less than its market value because it takes into account the cost of selling the asset quickly.

• A person who takes out a mortgage to buy a house pledges the house as collateral for the loan.
• When someone borrows money to buy a car, the car becomes the collateral for the loan.
• A business owner who needs a loan to buy equipment may pledge the equipment as collateral.

These examples illustrate how collateral works. If the borrower fails to make payments on the loan, the lender can take possession of the collateral and sell it to recover the money owed. For example, if a homeowner defaults on a mortgage, the lender can foreclose on the house and sell it to recover the money owed. The same is true for a car loan or a business loan secured by equipment.