Collateral is an asset that a lender accepts as security for extending a loan. Collateral security is any property-movable or immovable property offered for securing a loan. A commercial bank is a type of an organization that deals in credit i,e. it accepts deposits from the public withdraw able by a cheque and it advances, short-term loans. It is extra security provided by a borrower to back up his/her intention to repay a loan. It is the secondary security, is used when Primary Security is not sufficient to cover the whole loan amount in case of default by the borrower. Collateral can take the form of real estate or other kinds of assets, depending on what the loan is used for. The lender has the right to seize the collateral if the borrower defaults on the obligation.
It is used as a way to obtain a loan, acting as a protection against potential loss for the lender should the borrower default in his payments. For example, if a person wants to take out a loan from the bank, he may use his car or the title of a piece of property as collateral. The primary security on a substantial business loan is typically the thing that is being financed, such as a factory, company car or shipment, but secondary or collateral security might also be requested by a bank to help assure that the loan will be repaid. It is usually something that the bank or person you want to borrow money from can get just in case you couldn’t pay them back what you owe. If you do in fact default on the loan, the loan agreement gives the lender the right to seize and then sell the collateral in order to recover any outstanding balance.
Importance of Collateral Security –
- In the case of Cash credit Limits, Stock and book debt are primary security. But a borrower may sell Stocks and book debts, so the bank requires additional security (collateral) in the form of immovable assets (building, land) to secure the loan.
- In the case of Housing Loan, Car Loan, and Personal Loan, collateral security is not required. The security might be kept with the lender or the customer (borrower) on the basis of the type of security.
- Bank Loans without collateral are known as collateral-free loans. A form of secondary protection sometimes required by a bank and intended to guarantee a borrower’s performance on a debt obligation.