Collateral offers lenders a degree of security in the event a borrower cannot fulfill the terms of a loan agreement. So, what is collateral? Any asset owned by a borrower that can be pledged to help a lender recover their investment in the event of a loan default is referred to as collateral. As defined by the experts at Yieldstreet, collateral helps borrowers secure capital to finance investments or make large purchases.
Here are five types of assets that can serve as collateral.
Five Types of Collateral
Real Estate – It is common in real estate transactions for the property being purchased to serve as security for the loan. An agreement of this nature technically makes the lender the owner of the property until the terms of the loan are met to the satisfaction of all signatory parties. Property held in this fashion is said to have a consensual lien against it— meaning the borrower agrees the lender will be paid first in any transaction involving change of ownership of the collateralized property.
Accounts Receivable – Some retailers pledge their accounts receivable as collateral in order to secure capital before their invoices mature. This practice is also known as invoice factoring. Factoring transfers ownership of a debt from the retailer to the lender. In other words, when the retailer’s customer satisfies an invoice, the funds go to the lender first, then the difference between the factored amount and the invoice amount goes to the borrower. It should be noted this is not without risk for the lender, as the customer could default on the invoice, leaving both the lender and the retailer in the lurch.
Cash – Any loan against which a down payment is made is a collateralized loan. The funds comprising the down payment serve as the lender’s security. In most instances, the cash will be surrendered, along with the item against which the loan is written in the event of a borrower default. Cash can also be used to secure a loan in a more traditional way. The borrower can promise to pay a certain amount of cash if the terms are not met in the loan agreement.
Investment Accounts – Stocks, bonds and other types of securities owned by borrowers can also serve as collateral for loans. In the event of a default in an agreement of this type, the lender assumes ownership of the pledged securities. Some investors choose to leverage their holdings in this fashion as a tool to acquire positions in additional investment opportunities.
Collectibles — Items such as artwork, cars, watches and other rare items, which can be liquidated quickly, are often used to serve as collateral as well.
In Summary
Assets must be capable of being assigned a verifiable value to serve as collateral. The borrower must own the asset and sign a security agreement pledging it. Intangible items such as patents or debts owed to the borrower may also be used as collateral.
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