Collateral

What is collateral?

Not to be confused with Tom Cruise's English film of the same name, Borrowing a Knife to Kill, collateral is real estate or other assets that you mortgage to a lender as security to help you obtain a loan. When you borrow money, you agree that if you fail to repay the debt, the lender may obtain certain assets of yours. This is a secured loan.

Where have you heard of collateral?

A common collateral in everyday life is a home purchase mortgage loan. The property is collateral. If you fail to repay the loan under the terms of the mortgage agreement, the lender may take possession of your home.

Information you need to know about collateral...

Collateral acts as security for the lender, so such loans are less risky and usually have lower interest rates than unsecured loans. If you use a credit card to borrow money, the interest rate may be significantly higher than a mortgage or personal loan because there is no collateral.

In margin trading, investors borrow some of their money to buy shares from the broker who handles the trade. In the event of a margin call, the investor uses the securities in the brokerage account as collateral. If the investor is unable to deposit the necessary funds on time, the broker may liquidate the investor's securities to meet the maintenance margin requirements.

Collateral falls into five broad categories: consumer goods, commercial equipment, agricultural products, inventories, and stocks and bonds. Many new enterprises are also required to provide collateral because they have no record of past profits.