What is collateral?

Collateral is personal or real property that is pledged or title to which has been assigned to secure the satisfaction of an obligation.  Although the use of assets to secure lending is generally costly and time-consuming, it results in lower interest on debt financing due to the reduced credit risk and the lender’s lower regulatory capital costs.  Most legal systems distinguish between collateral in the form of personal property or real property.

Collateral = Pledged or Assigned Personal or Real Property

An enforceable claim or interest in property created by agreement or operation of law to secure payment or performance of an obligation is a security interest, with its beneficiary having certain preferential rights in the disposition of the collateral.  A security interest gives the secured parties the right to seize or restrict the sale of the collateral in the event of the debtor’s default.  Collateral proceeds are the cash arising from disposition of collateral and the rights and certain claims against the collateral, first against expenses resulting from the collateral’s sale, then to secured creditors’ claims and lastly to any unsecured, subordinated creditors.

Security Interest = Collateral + Collateral Proceeds

Any claim against personal property, real property or funds to secure the payment of a debt or performance of some other obligation that exists until the debt or duty that it secures is satisfied is a lien.  In some countries, a lien simply refers to nonpossessory security interests and a wide range of encumbrances; in other countries, it refers to a passive right to retain – not to sell – property until the obligation is discharged.  A lien may be consensual and assigned voluntarily, such as a mortgage in real estate, or nonconsensual arising involuntarily by statute or operation of law, such as a judgment, mechanic’s or tax lien.