What is collateral and how does it work?

Collateral is an asset or property that a borrower pledges as security to obtain a loan or other credit. In case the borrower defaults on the loan, the lender can seize the collateral and sell it to recover the amount due.

For example, a borrower can pledge their home or car as collateral when taking out a mortgage or auto loan. If the borrower defaults on the loan, the lender can foreclose on the home or repossess the car to recover the outstanding debt.

Collateral provides security to the lender and reduces the risk of default, which in turn can result in lower interest rates or higher loan amounts for the borrower.