Collateral is an asset that a borrower offers to a lender as security for a loan. If the borrower fails to repay the loan, the lender has the legal right to seize the collateral to recover their money. In the context of mortgages, the property being purchased (or already owned, in the case of a remortgage) serves as the collateral.
Because a mortgage is a secured loan backed by collateral, lenders can offer lower interest rates than they would for unsecured borrowing such as personal loans or credit cards. The property gives the lender confidence that they can recover the outstanding debt even if the borrower stops making repayments.
The lender's interest in the collateral is protected by registering a charge against the property at the Land Registry. If the borrower defaults, the lender can ultimately apply to the courts for repossession and sell the property to recover the amount owed.
When you take out a mortgage to buy a house, the house itself is the collateral. The lender registers a charge against it. If you were to stop making repayments, the lender could eventually repossess the house and sell it to recover the debt.
Key Points
- An asset pledged as security for a loan
- For mortgages, the property is the collateral
- Allows lenders to offer lower interest rates than unsecured lending
- The lender registers a charge against the collateral at the Land Registry
- If the borrower defaults, the lender can repossess and sell the property