What is a collateralized loan?

A collateralized loan is specifically a loan that is secured by collateral, which is an asset that the borrower pledges to the lender to mitigate the lender's risk. If the borrower fails to repay the loan, the lender has the legal right to seize the collateral to recover the owed amount. This security reduces the risk for lenders, which can lead to lower interest rates for borrowers compared to unsecured loans. Collateral can take various forms, including real estate, equipment, or other valuable assets.

The nature of collateralized loans provides a safety net for the lender, thereby making it easier for borrowers to obtain financing, especially for larger loan amounts. Understanding the concept of collateral is essential in financial literacy, as it highlights the importance of securing loans with tangible assets to prevent default and financial loss.