If you’ve ever discussed alternative investing with a creditor, chances are you’ve heard the word “collateral” mentioned numerous times. Even if you’ve simply discussed a personal loan with your financial institution, collateral can impact your status as a borrower.
As such, it’s essential to know how collateral works in the United States, whether it can impact your investments, and why lenders would be interested in collateral.
If you’re looking for a simplified collateral definition, it’s an asset that a borrower pledges to a lender to help secure a loan. If the borrower defaults on the loan terms or the borrower fails to make adequate payments to the lender, the lender can then foreclose on the collateral. When the repayment of a loan is involved, the lender commonly tries to sell the borrower’s collateral to pay off the loan amount. This legal right for a debtor to sell the collateral is also known as a lien.
Naturally, there are several different types of borrower collateral. Many borrowers in the United States choose to put up their savings account. This type of collateral counts as a form of personal property or a personal asset. Outside of a bank account, an applicant may choose to put up their real estate when securing collateral loans. For a creditor, real property is seen as a solid form of collateral since real property usually carries a high value. Other types of collateral include accounts receivable, inventory, and equipment collateral, though there are also more alternative asset classes that qualify.
Can collateral impact interest rates?
In the United States, there are two primary types of loans known as secured loans and unsecured loans. An unsecured loan often carries a higher interest rate and larger monthly payment due to its riskier nature. On the other hand, secured collateral loans may have a lower interest rate depending on the account type, the issuer, the loan agreement, and the borrower’s credit history. Secured lending is preferred by your average broker since it carries a much smaller risk of non-payment. However, the occasional broker will consider an unsecured loan even if they can’t collect on collateral damage.
While it may happen that an issuer will consider collateral for a mortgage loan, it’s also incredibly common for applicants to put up collateral lines on a small-business loan. An issuer may ask a prospective applicant to put up collateral lines such as accounts receivable, inventory, and other business assets. However, if the total appraised value of your business assets is less than that of the loan, you may be asked to put up additional fixtures to cover the added expense values of the loan.
Collateral and Alternative Investments
While collateral commonly impacts the debtor, borrower, and lender, it can have unique implications for the investor. Since collateral is the fundamental core of asset-based finance practices, there’s potential for collateral to be offered up in the form of an alternative investment offering. This is commonly seen in the real estate market. A certain home or fixture which has been used as collateral may be the ideal investment vehicle for the savvy investor.
In other markets, including litigation finance, the pledged collateral may include claims damages (collateral damage) from a pre-settled case. If you’re still unsure of how collateral can impact alternative investments, different platforms like Yieldstreet can help. They offer useful resources that make it easier to understand the impact of asset-based financing on the debtor, lender, or borrower.
Though the concept of collateral is more complicated than, say, opening up a new credit card, it’s a fixture of asset-based finance. Understanding collateral is critical for a wide variety of financial processes and can give you better insight into how different loans and investment platforms work.
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