Definition of Collateral

What does the term "collateral" mean? What is the definition of the term "collateral" as it relates to the world of finance?

"Collateral" is something of tangible value that an entity (individual or company) can pledge against money that is owed.

For instance - let's say that you want to take out a loan of $300,000 to perform some extensive renovations on your primary home.

You decide to take out a "secured loan" in order to finance the renovations. A "secured loan" means that you are pledging the equity in your home against the loan. So, if you default on the loan, the bank can take your house.

Another example of collateral - you borrow $5,000 from a personal friend. You don't have the best history when it comes to paying back money, so your friends asks you to pledge your comic book collection as collateral. When the loan is repaid, he says, he will return the comic book collection.

You have a total of 5 years to pay back the money, with an annual interest rate of 5%. if the loan isn't repaid after 5 years, the comic book collection will belong to your friend, as per the terms of the loan.

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