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In lending agreements, collateral is a
borrower's
borrower's
pledge of specific
property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depending on the nature of the property, an owner of property may have the right to consume, alter, share, r ...
to a
lender A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

lender
, to secure repayment of a loan. The collateral serves as a lender's protection against a borrower's
default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It ...
and so can be used to offset the loan if the borrower fails to pay the
principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academic officer of a university A university ( la, universitas, 'a whole') is an educational institution, institution of higher ...
and
interest In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availa ...

interest
satisfactorily under the terms of the lending agreement. The protection that collateral provides generally allows lenders to offer a lower
interest rate An interest rate is the amount of interest In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investm ...
on loans that have collateral. The reduction in interest rate can be up to several percentage points, depending on the type and value of the collateral. For example, the
Annual Percentage Rate 279px, Parts of total cost and effective APR for a 12-month, 5% monthly interest, $100 loan paid off in equally sized monthly payments. The term annual percentage rate of charge (APR), corresponding sometimes to a nominal APR and sometimes to an e ...
(APR) on an
unsecured loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availab ...
is often much higher than on a
secured loan A secured loan is a loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers an ...
or
logbook loan A logbook loan is a form of secured lending in the United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain,Usage is mixed. The Guardian' and Telegraph' use Britain as a syn ...
. If a borrower defaults on a loan (due to
insolvency In accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been call ...
or another event), that borrower loses the property pledged as collateral, with the lender then becoming the owner of the property. In a typical
mortgage loan A mortgage loan or simply mortgage () is a loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money ...
transaction, for instance, the
real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more genera ...

real estate
being acquired with the help of the loan serves as collateral. If the buyer fails to repay the loan according to the mortgage agreement, the lender can use the
legal process Legal process (sometimes simply process) is any formal notice or writ by a court obtaining jurisdiction over a person or property. Common forms of process include a summons, subpoena, Mandate (criminal law), mandate, and warrant (law), warrant. ...
of
foreclosure Foreclosure is a legal process in which a lender A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. ...
to obtain ownership of the real estate. If a
second mortgage Second mortgages, commonly referred to as junior liens, are loans secured by a property in addition to the primary Mortgage loan, mortgage. Depending on the time at which the second mortgage is originated, the loan can be structured as either a st ...
is involved the primary mortgage loan is repaid first with the remaining funds used to satisfy the second mortgage. A
pawnbroker A pawnbroker is an individual or business (pawnshop or pawn shop) that offers secured loans to people, with items of personal property used as Collateral (finance), collateral. The items having been ''pawned'' to the broker are themselves c ...
is a common example of a business that may accept a wide range of items as collateral. The type of the collateral may be restricted based on the type of the loan (as is the case with auto loans and mortgages); it also can be flexible, such as in the case of collateral-based personal loans.


Concept

Collateral, especially within
banking A bank is a financial institution Financial institutions, otherwise known as banking institutions, are corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), stat ...

banking
, traditionally refers to secured lending (also known as
asset-based lending Asset-based lending is any kind of lending secured by an asset. This means, if the loan is not repaid, the asset is taken. In this sense, a Mortgage loan, mortgage is an example of an asset-based loan. More commonly however, the phrase is used to de ...
). More-complex collateralization arrangements may be used to secure
trade Trade involves the transfer of goods from one person or entity to another, often in exchange for money. Economists refer to a system A system is a group of Interaction, interacting or interrelated elements that act according to a set of r ...

trade
transactions (also known as ''capital market collateralization''). The former often presents unilateral obligations secured in the form of
property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depending on the nature of the property, an owner of property may have the right to consume, alter, share, r ...
,
surety In finance, a surety , surety bond or guaranty involves a promise by one party to assume responsibility for the debt obligation of a borrower if that borrower defaults. Usually, a surety bond or surety is a promise by a surety or guarantor to pay o ...
,
guarantee Guarantee is a legal term more comprehensive and of higher import than either warranty or "security". It most commonly designates a private transaction by means of which one person, to obtain some trust, confidence or credit for another, engages ...
or other collateral (originally denoted by the term ''security''), whereas the latter often presents bilateral obligations secured by more-liquid assets such as
cash In economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among individuals within those societie ...
or
securities A security is a tradable financial asset A financial asset is a non-physical asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication o ...
, often known as margin.Collateralization of assets gives lenders a sufficient level of reassurance against default risk.It also help some borrowers to obtain loan if they have poor credit histories. Collateralized loans generally have substantially lower interest rate than unsecured loans.


Marketable collateral

Marketable collateral Marketable collateral is the exchange of financial assets A financial asset is a non-physical asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything ( ...
is the exchange of
financial assets A financial asset is a non-physical asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positiv ...
, such as stocks and bonds, for a loan between a financial institution and borrower. To be deemed marketable, assets must be capable of being sold under normal market conditions with reasonable promptness at current
fair market value The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code The Internal Revenue Code (IRC), formally the Internal Revenue Code ...
. For national banks to accept a borrower's loan proposal, collateral must be equal to or greater than 100% of the loan or credit extension amount. In the United States of America, the bank's total outstanding loans and credit extensions to one borrower may not exceed 15 percent of the bank's capital and surplus, plus an additional 10 percent of the bank's capital and surplus. Reduction of collateral value is the primary risk when securing loans with marketable collateral. Financial institutions closely monitor the
market value Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a Market (economics), competitive auction setting. Market value is often used interchangeably with ''open market value'', ''fair value'' or ''fair market va ...
of any financial assets held as collateral and take appropriate action if the value subsequently declines below the predetermined maximum loan-to-value ratio. The permitted actions are generally specified in a loan agreement or margin agreement. Tokenization of securities like company shares, pharmaceutical & defence project patents and mining licenses is an emerging novel concept of dynamic investment despite still being considered and classified as relatively experimental. Spektral Investment Bank is currently the only example of above mentioned novel complete tokenization concept via establishment of 800.000.000.00 EU worth in-kind collateral based capital composed of exclusive pharmaceutical & bioceucal patent rights and reserve volume approved mining licenses.


Examples of Collateral

Intellectual property Intellectual property (IP) is a category of property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depending on the nature of the property, an owner o ...
such as
copyrights Copyright is a type of intellectual property Intellectual property (IP) is a category of property that includes intangible creations of the human intellect. There are many types of intellectual property, and some countries recognize more ...

copyrights
,
patents A patent is a type of intellectual property Intellectual property (IP) is a category of property Property is a system of rights that gives people legal control of valuable things, and also refers to the valuable things themselves. Depe ...

patents
, and
trademarks A trademark (also written trade mark or trade-markThe styling of ''trademark'' as a single word is predominantly used in the United States and Philippines only, while the two-word styling ''trade mark'' is used in many other countries around ...

trademarks
, as well as royalty streams from licensing revenue, are increasingly being used as collateral. The use of IP as collateral in IP-backed finance transactions is the subject of a report series at the
World Intellectual Property Organization The World Intellectual Property Organization (WIPO; french: Organisation mondiale de la propriété intellectuelle (OMPI)) is one of the list of specialized agencies of the United Nations, 15 specialized agencies of the United Nations (UN). Pu ...
.


See also

* Auto-collateralisation *
Consignment Consignment is the act of consigning, the act of giving over to another person or agent's charge, custody or care any material or goods but retaining legal ownership until the material or goods are sold. That may be done for the purpose of shippi ...
*
Credit Support AnnexA Credit Support Annex, or CSA, is a legal document ''Legal instrument'' is a legal term of art Jargon is the specialized terminology Terminology is a general word for the group of specialized words or meanings relating to a particular field, a ...
*
Cross-collateralizationCross-collateralization is a term used when the Collateral (finance), collateral for one loan is also used as collateral for another loan. If a person has borrowed from the same bank a home loan secured by the house, a car loan secured by the car, a ...
*
Hypothecation Hypothecation is the practice where a debtor pledges collateral to secure a debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred paymen ...
* Intellectual asset finance *
Security depositA security deposit is a sum of money held in trust either as an initial part-payment in a purchasing process (often used to prevent the seller selling an item to someone else during an agreed period of time while the buyer verifies the suitability ...

Security deposit
*
Security interest In finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in ...
*
Shadow banking system The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal banking regulations. The phrase "shadow banking" contains the pejorative ...


References

{{Authority control Business terms Credit Liability (financial accounting) Loans