Collateral is an asset that a lender accepts as security for a loan. Collateral can be in the form of various assets including real estate, but all depends on what purpose the loan serves. A main service of the collateral is that it acts as a form of protection for the lender. However, if the borrower defaults on their loan payments, the bank (or whoever is considered the lender) can seize the collateral to sell it back to make up for what is has lost.
Lenders look to use a collateral as it ultimately minimizes the risk. Other types of collaterals are mortgages or car loans. However, in order to secure a collateral personalized loan many individuals use their personal assets such as savings or investment accounts.
Before you can take out a loan, the lender must be able to confirm you will have the ability to pay it back which includes a form of security. The security described is called collateral which is what helps lenders ensure that the borrower in consistently keeping up with payments. If the borrower does not keep up with their end of the payments, the lender can sell it and apply to money it gets to the unpaid portion of the loan. Then the lender can choose to pursue legal action against the borrower if they so do wish.
Loans secured by collateral are typically available at substantially lower interest rates than unsecured loans. A lender's claim to a borrower's collateral is called a lien—a legal right or claim against an asset to satisfy a debt. The borrower has a compelling reason to repay the loan on time because if they default, they stand to lose their home or other assets pledged as collateral.
Borrowers can use future paychecks as collateral for short-term loans, and not just from payday lenders. Traditional banks offer such loans however they don’t last longer than a couple of weeks. These short-term loans are an option in an emergency; however, you should always compare different rates.