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Collateral is a way to secure debt and provide recourse to lenders when a borrower defaults on a loan. When a borrower wants to obtain a loan without collateral, a lender cannot be sure that the borrower will repay that loan. Collateral helps increase trust amongst counterparties to reduce the possibility of default. If the borrower defaults, the lender may obtain ownership of the collateral until the borrower’s debt is repaid.

Sometimes, the asset itself becomes collateral for a loan. For example, a car can be collateral for a car loan, and the home itself is collateral on a home mortgage. In those cases, repossession of the asset minimizes risk for lenders.

Another example of collateral is a home equity line of credit, where a borrower collateralizes their home in exchange for an additional loan. If the borrower defaults on a home equity loan, the lender may foreclose on the home and repossess the title to the property. Deposit accounts may also be offered as collateral.