Collateral: Definition, Types & Examples

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  • 0:01 Definition of Collateral
  • 0:51 Types of Collateral
  • 1:35 Examples of Collateral
  • 3:39 Lesson Summary
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Lesson Transcript
Instructor: Michael Cozad

Michael is a financial planner and has a master's degree in financial services.

This lesson will define collateral from the viewpoint of both an individual and a business owner. Also in this lesson, various types of collateral will be explained, and examples of collateral will be explored.

Definition of Collateral

Have you ever borrowed money from a friend and made assurances to pay them back? Maybe you even gave more than just verbal assurances and also pledged that you would give up something of yours if you didn't pay them back in time? For instance, you might have said, 'I promise to pay you back, and if I don't, you can have my stereo.' What you pledged your friend -- your stereo -- is collateral.

Collateral is when an asset is pledged to secure repayment. It is common in personal and business lending. You may hear friends or family refer to collateral as a home, a car, or a commercial building or property. These examples are not all-inclusive; rather, they are provided to illustrate various types of collateral you may encounter in your lifetime.

Types of Collateral

There are five main types of collateral: consumer goods, equipment, farm products, inventory, and property on paper.

Consumer goods are products purchased by the mainstream consumer, such as an automobile.

Equipment includes items predominantly used in business or government operations.

Farm products include livestock and crops.

Inventory consists of raw materials or work in progress.

Property on paper includes stocks, bonds, and even funds held in a savings or checking account.

It is important to note that this list is not all-inclusive; almost anything of value (within reason, of course) can be offered as collateral.

Examples of Collateral

Let's explore different collateral an individual could use throughout different stages of his or her lifetime.

Let's call Stage 1: The College Graduate

John Doe, a recent college graduate, is in the market for a car. When John graduated from college, his dad gave him a family heirloom, a watch valued at $3,000. John is in the market for a $5,000 car but has limited credit history and little cash on hand.

John recently started a new job and expects to be able to afford monthly car payments of a few hundred dollars. He's looking through the paper and sees that one of his neighbors is selling their used car for $5,000. John can use his watch as collateral to the seller, if the seller desires it. This could give John a better interest rate, as the potential worst-case scenario to the seller is that he ends up with a watch valued at $3,000.

After a few years, John has married, upgraded his vehicle, and is burnt out at his job. Now he's on to Stage 2: The Entrepreneur.

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