Collateral

What is Collateral?

Collateral is an asset pledged by a borrower to a lender as security against a loan, giving the lender a legal claim to the asset if the borrower fails to make required payments. Common forms of collateral include real estate (securing mortgages), vehicles (securing auto loans), business inventory and equipment (securing commercial loans), and investment portfolios (securing margin loans). Secured loans backed by collateral typically carry lower interest rates than unsecured loans because the lender's loss exposure is reduced by the ability to recover value through asset liquidation. The value of collateral relative to the loan amount is measured by the loan-to-value (LTV) ratio; lenders prefer lower LTV ratios to ensure adequate coverage even if asset values decline. Over-collateralization—pledging more value than the loan amount—is common in business lending and DeFi protocols.