Collateral is an item of value, such as property or assets, that is pledged by an individual (borrower) in order to guaranty a loan. Upon default, the collateral becomes subject to seizure by the lender and may be sold to satisfy the debt. The value of collateral is not based on the market value. It is discounted to take into account the value that would be lost if the assets had to be liquidated in order to pay off the loan.
For example, in securing a mortgage, the borrower’s home becomes the collateral. If the borrower takes out a car loan, then the car becomes the collateral for the loan.
[Last updated in July of 2022 by the Wex Definitions Team]