In many credit agreements such as secured loans, a borrower is required to pledge some assets as collateral for the loan. These assets can be seized by the lender when such borrower defaults on the repayment of the loan. Collateralization is a situation whereby a borrower offers a specific property or assets to a lender to secure the loan in the event of the borrower’s default on the loan. Collateralization can also be used by traders in the capital market when used, a trader pledges an asset or security to secure the transaction.
Collateralization gives lenders the confidence to issue a loan to the borrower, and an assurance that the loan will be repaid.
A Little More on What is Collateralization
Generally, secured loans are collateralized loans, these are loans backed by collaterals that give the lender an assurance of repayment. Apart from loan agreements, collateralization is also used for transactions in the capital market, real estate, automobiles, securities, and others. In any transaction that collateralization is used, the value or amount of the initial loan determines the value of assets or properties to be used as collateral. In other cases, the worth of the collateral determines the value of the loan to be issued. As a means of protecting themselves against default, lenders issue loans that are between 70% to 90% of the asset or property used as collateral.
Mortgage financing is a form of loan that is backed up by a borrower’s title to the property. Without a valid title, it is difficult to secure a mortgage loan. Having been used as collateral for the loan, the lender holds the right to the title of the property until the borrower makes full payment of the principal and interest of the loan. In the vent of borrower’s default, the lender can claim the property which can be sold to recoup the losses incurred from the borrower’s default. Title to property enables a borrower to secure a mortgage loan.
Business loans are forms of secured loans that use collateral for their credit lendings. Depending on the value of the loan, collaterals used for business loans differ. Examples of collaterals used are a business facility, equipment and machinery, securities, stocks and bonds, and others. For a business to secure a loan, it must pledge its asset or securities as collateral which assures the lender the repayment of the loan. In the event of default, the lender can also sell the collateralize assets to recover the lost loan value. Oftentimes, business loans use underwriters who facilitate the loan deal, the underwriter can also seize the collateralized property to make repayment.
Securities as Collateral
Collateralized securities occur in the investment market when investors try to obtain loans from brokerage firms, they are required to use their investment holdings or the securities in their investment account as collateral. When securities are used as collaterals, the Federal Reserve regulates and oversees this form of collateral use.