The concept of collateral is simple to understand even though the many types of accepted collateral are varied, diverse and potentially unique to each loan scenario. Collateral is essentially what makes a secured loan secure. Collateral is any land, property, possession, investment or other item accepted by the lender as equal value to the amount of money being borrowed. Secured loans require collateral to reduce the risk of lending.
The benefit to the lender is the guarantee of repayment. The benefit to the borrower is usually a lower APR due to the lender feeling comfortable funding the loan. Putting up collateral does involve some risk to the borrower, however. A common scenario involving the use of collateral is a car loan. A lender puts up money used to purchase a vehicle.
The title is placed in the borrower’s name, but the borrower is not allowed to hold or possess the title until the car loan is paid in full. If the borrower defaults on the loan, the lender can repossess the car.
Another common scenario involving the use of collateral is a home mortgage loan. The lender funds the purchase of the home, but has the right to foreclose on and take possession of the home if the borrower defaults on the loan.
In each separate case the car and the home are used as collateral to secure the loan.
There are loans secured by items other than cars or homes. Seniors are able to use certain money markets or other savings accounts as collateral. Jewelry and boats are also commonly used as collateral for personal secured loans. Sometimes insurance policies, pension funds, gold or silver bullion and other valuable possession are used.
Lenders attempt to use collateral related to the loan purpose such as a car for a car loan or a house for a home loan. Equity in a home is the most common type of collateral used by seniors when applying for secured loans, however, the borrowed funds are used for a wide variety of important purposes.