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In the event that the borrower is unable to pay back the loan, the lender may seize the collateral in an attempt to recoup some or all of the loan amount.
A lender’s claim to collateral is called a lien.
Although it is typical for the asset being borrowed against to be put up as collateral, a variety of assets may be offered as collateral—including real estate, vehicles, and even heirlooms with monetary value.
What Is Collateral?
If a loan is secured by collateral, it is usually offered at a lower interest rate.
The purpose of collateralized loans, therefore, is to make secured loans less risky to lenders, and more affordable to borrowers.
However, defaulting on a collateralized loan is more costly than defaulting on a normal loan because the assets securing the loan will be repossessed by the creditor.
When considering a collateralized loan, borrowers should only work with trusted financial institutions.
Examples of Collateral Loans
Some common examples of collateralized loans are home mortgages or car loans in which the house or car is used as collateral.
Many institutions also accept bank savings deposits, investment accounts, and even future paychecks as collateral.
Borrowers should be careful before taking on a collateralized loan, as “predatory lending” has caused borrowers to unnecessarily lose assets, which is especially common with payday loans.