What is collateral in financial terms?

Collateral refers to an asset that a borrower pledges to a lender as a guarantee against a loan. If the borrower fails to repay the loan as agreed, the lender has the right to take possession of the collateral to recoup their losses. This process reduces the lender's risk and often allows borrowers to secure loans more easily, possibly at better interest rates.

Understanding collateral is crucial in the context of lending and borrowing because it serves as a form of security for the lender. The nature of collateral can vary widely, including properties, cash, investments, or inventory, depending on the type of loan and the lender's policies.

Offering collateral can also influence the terms of the loan, such as the amount that can be borrowed or the interest rate applied, making it a key element in financial transactions involving secured loans.