Collateralization

DEFINITION of 'Collateralization'

The act where a borrower pledges an asset as recourse to the lender in the event that the borrower defaults on the initial loan. Collateralization of assets gives lenders a sufficient level of reassurance against default risk, which allows loans to be issued to individuals/companies with less than optimal credit history/debt rating.

BREAKING DOWN 'Collateralization'

Mortgage financing allows borrowers to hold title over their own home despite acquiring it via borrowed funds. However, in the terms of the mortgage, if the borrowers default on the mortgage payments, the lender has a right to sell the property to recoup the loan amount.

Businesses can use collateralization for debt offerings. Such bonds may go into details as to the specific asset, such as equipment and/or property that is being pledged for the repayment of the bond offering in the event of default. The increased level of security offered to a bondholder typically means that the coupon rate offered on the bond will be lower as well.

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