A borrower’s pledge of a property/ assets to a lender or creditor in order to secure repayment of a loan or obligation. In this sense, the collateral helps protect a lender/ creditor against default by borrowers/debtors- that is, in case they fail to pay the principal and interest on a timely basis as set out in the lending contract. If a borrower fails to service a loan due to financial distress or insolvency, then the property pledged as collateral will be forfeited by the lender who has it in its possession, holding whereby the right to dispose of it and redeem any dues out of the sale proceeds. High-quality collateral reduces default risk to the lender as well as the interest burden on the borrower (interest rate negatively correlates to the amount of default risk associated with a loan).

An example of collateral is the securities posted by a borrower in a repo agreement against the loaned funds.