Collateral is an important feature of finance in the current loan and banking world. Every time a person borrows money from the lender or the bank, there needs to be some sort of assurance that the lending party or the bank will get the money given out in the loan and the interest as well. Otherwise, there is a high probability that the borrowing party will not pay the loan principal and the interest.

The lending party, in order to make sure that an assuring term is added to the contract, demands collateral.

Collateral is basically an immovable asset such as a piece of land, a house, property or anything with high value. The value of the collateral is high enough for the bank to reclaim their original amount that was lent out to the borrowing party as well as the interest payments associated with that principal.

In the event that an individual or a business is unable to pay the interest to the amount or is unable to repay the loan in the stipulated amount of time given to them, the bank or the lending party is in a position to sell the collateral and reclaim the loaned principal and the interest amounts associated with it. This is made possible as during the loan, the lending party gets the borrowing party to sign a document giving the lending party a hold on the rights of the immovable asset, thus giving the lender the authority to sell the property in the event of the borrowing party's default of the contract policy.  Collateral plays an exceedingly important role in mortgage agreements as these agreements are primarily based on collateral itself.

Collateral ensures that the lender is secure in his loan amounts that have been given out, and gives a sense of relief, assurance and helps them remain economically sound. On the other hand, collateral is not always required in order to process a loan to the lending party. In the case of unsecured loans, there is no such collateral involved in the policy, and the lender can avail of a loan from the bank.  Unsecured loans are not however loose loans. These loans are just given out on the basis of good credit reports, instead of usual loans like secured loans that given out only on the basis of the collateral submitted to the bank. However, secured loans that avail a collateral are usually given out at very low interest rates.

Repaying a secured loan is a lot easier than repaying an unsecured loan, as again, the unsecured loan has high interest rates. It is important that the collateral is already only in the name of one person, the borrowing party. The property will then be transferred to the name of the bank as well, once the loan has been sanctioned. This gives the bank some rights to the property.

The process, by which the bank or the lending party obtains the property or collateral from the borrowing party that has defaulted the loan agreement, is called foreclosure.