Collateral
Definition
An asset you pledge to a lender as security for a loan. If you fail to repay, the lender can seize it. Your house is collateral for a mortgage. Your car is collateral for an auto loan. Collateral usually gets you a lower interest rate.
Why It Matters
Collateral makes lenders comfortable lending to you. A car loan is cheaper than a personal loan because the lender can repossess the car. Understanding collateral helps you get better rates and understand the risks.
Example
Borrow $25,000 for a car. You pledge the car as collateral. If you default, the lender repossesses it and sells it to recover their money. Because of the collateral, the lender offers 4% interest instead of 8% for an unsecured loan.