Difference between Collateral and Security

Whenever a consumer, usually referred to as a borrower, decides to take out a loan, he or she will need to offer something in return which will be considered as a collateral or security for the loan amount. Financial institutions require some sort of guarantee when they hand out any money to the borrower in order to protect themselves from possible defaults.

While collateral and security may be perceived in the same mould, differences exist in how the two terms are eventually applied. Collateral is basically a borrower’s pledge to lock loan payments and serves as an assurance for the lender. Therefore, to a financial institution such as bank, it is perceived as secure lending. This term is largely used in the United States when a homeowner is seeking a mortgage loan. He or she will therefore pledge something in return in a bid to satisfy the lender’s needs. This usually comes in the form of assets with physical appearances such as land, building, equipment, cars etc.

Securities, on the other hand, are perceived as complex collateral arrangements between a borrower and a lender, where the former offers more liquid assets such as bonds, stocks etc. These are traded on various stock exchanges, with cash only offered after the securities have been liquidated.

Collateral or asset based lending is considered as a safer pledge, as the lender exactly knows the amount he or she will get if the borrower defaults. However, securities are dependent upon market fluctuations and any negative variations will leave the lender worse off when compared to the loan amount he or she has offered to the borrower. If such a scenario occur, then the lender may be entitled to ask the borrower for additional collateral.

In general, the term ‘collateral securities’ is applied when referring to the financial market securities, where the lender will also earn the margin amount or the profit associated with the investment made by the borrower.