What is collateral in finance?

Collateral in finance refers to property or assets that a borrower pledges to a lender as security for a loan. This means that if the borrower fails to repay the loan, the lender has the right to seize the collateral to recover their losses. Collateral can take various forms, including real estate, vehicles, stocks, or other tangible property that holds value. The use of collateral reduces the risk for the lender and can often lead to more favorable loan terms for the borrower, such as lower interest rates, because it provides the lender with a claim to the asset in case of default. This concept is vital in lending as it helps protect the lender's investment and ensures that borrowers have a vested interest in repaying the loan.

Other options do not accurately capture the essence of collateral. A type of equity investment relates to ownership in a company, a financial term for interest rates pertains to the cost of borrowing money, and a government-funded loan program describes a method by which loans are made rather than the concept of securing a loan.