What does "collateral" refer to in a loan?

In the context of a loan, "collateral" specifically refers to an asset that a borrower pledges as security for the loan. This means that if the borrower fails to repay the loan, the lender has the right to seize the collateral to recover their losses. Collateral can take many forms, such as real estate, vehicles, or other valuable assets, depending on the terms of the loan and the policies of the lending institution.

This concept is critical because it provides a layer of protection for the lender, encouraging them to offer loans with potentially lower interest rates or better terms, as the risk is mitigated by the assurance that they can recoup their investment through the collateral if necessary.