What is collateral in financial terms?

Collateral refers to an asset that a borrower offers to a lender as security for a loan. This asset is a form of guarantee that the lender can claim if the borrower defaults on the loan or fails to meet the repayment terms. By pledging collateral, the borrower demonstrates their commitment to repay the loan, which may also lead to more favorable loan terms, such as lower interest rates or higher borrowing amounts.

For example, when obtaining a mortgage, the property itself is considered collateral. If the borrower cannot make the mortgage payments, the lender has the right to take ownership of the property through foreclosure. This significantly reduces the lender's risk, making it more likely for them to approve the loan.

In contrast, other options do not correctly define collateral. An insurance policy serves to protect investments from certain risks but does not provide security for a loan. Funds in a high-yield savings account represent savings rather than collateral for borrowing. An investment strategy based on real estate may involve leveraging properties but does not refer to the concept of collateral itself.