Collateral

Collateral is the term used to describe a property that is pledged as security against a loan.  A secured loan is backed by property in the possession of the borrower.  For example, a mortgage is a secured loan that uses the home itself as collateral.  In the same way, car loans use the car as collateral.

The use of collateral is important to the lending institution, since it gives them the ability to foreclose on a home, or repossess a car, to collect the remaining money owed, or principal, on a loan.  Collateral reduces the risk of the loan, and results in lower interest rates passed on to consumers.

Unsecured loans, such as credit card debt and student loans, do not involve collateral.