What Is a Collateral?

A collateral is a term commonly used in a lending arrangement. It refers to assets pledged by a borrower to a lender as security for a loan obtained by the borrower. The pledged asset, which could be movable or immovable, reassures the lender of the borrower’s commitment to pay back the principal and an agreed interest.

Consequently, if the borrower defaults, the lender will be entitled to exercise his right of sale over the pledged asset(s) to recoup some or all of the loan facility.

For example, Atticus obtained a $50,000 loan facility from his financial institution and offered his house valued at the current market rate of $75,000 as collateral. The failure of Atticus to pay back the loan at the agreed time will confer on his financial institution the right to dispose of the property to offset Aticcus’ loan obligations, including the accrued interest.

Usually, during the duration of the lending relationship, the borrower may not be able to sell the pledged asset without the permission of the lender. The consent is necessary because the lender is deemed to have a lien over the pledged asset(s).

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