Last editedJul 20212 min read
Collateral is the term used to describe any asset offered by a borrower to a lender as security for a loan. It acts as protection for the lender to ensure the money they lend can be repaid in one way or another. If the borrower fails to repay the loan, the lender takes ownership of the asset to recoup the loan amount.
A lender’s claim to collateral is called a lien, which gives the lender a legal right to the asset offered as collateral. In some instances, the asset will be seized and sold immediately to recoup the debt, or it can be seized and held until the borrower has paid off the debt in full.
Types of collateral
Borrowers can offer a variety of assets as collateral. The main types of collateral usually offered include:
Other items that are sometimes offered include vehicles and valuable objects, although these are often used collectively in inventory financing. Their value must also be verified before they are accepted as collateral.
Property and land are the most frequently offered type of collateral. This could be in the form of properties or land owned by the borrower as part of a portfolio or the home they live in. Real estate like this used to be favoured by lenders, although it has lost some of its lustre in recent years due to fluctuations and uncertainty in the housing market. However, it remains a popular asset to offer as collateral.
The collateral definition of inventory financing means a list of items that are offered as collateral for a loan. The inventory could contain any number of items whose combined value is enough to cover the loan. If the borrower using inventory financing fails to repay the loan, the inventory items are seized by the lender and sold to recoup the debt.
The invoice collateral meaning involves offering unpaid invoices as security against a loan. This type of collateral is often used by small businesses that secure a loan by providing outstanding customer invoices that haven’t been settled yet. Should the business default on the loan, those invoices will eventually be paid directly to the lender to recover the loss.
The collateral definition of a blanket lien means the lender has the legal right to seize any asset owned by the borrower in the event of non-payment of the loan. Theoretically, a blanket lien gives the lender a legal interest in all of the borrower’s assets as they technically all serve as collateral. Again, this type of collateral is most often offered by businesses that have numerous assets that can act as security.
Cash can also be used as collateral, especially when an individual has multiple active accounts at the same bank. An individual can take a loan from the bank where their accounts are managed, and if they fail to meet the payments, the bank can simply liquidate the accounts to recoup the amount still owed.
Loans without collateral
It is also possible to take a loan without offering any collateral, although the loan options are more limited. For example, loans for smaller amounts usually don’t require collateral and can be acquired more easily. The borrower would usually just need to demonstrate that they are in good financial health and are reasonably capable of repaying the amount due.
Online loans are also common these days, but they are usually for much smaller amounts and often involve higher interest rates. The would-be borrower fills in an application online, and the lender will either approve or reject it. Repayment arrangements are then made, as well as the interest rate agreed upon.
Another type of collateral-free loan is when you use a co-signer who acts as the security on the loan. If the borrower defaults, then the co-signer becomes responsible for the debt.
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