What Is Additional Collateral?
What Is Collateral?
Understanding Additional Collateral
Additional collateral is used to lessen the risk the lender takes on when issuing a loan. There are several reasons creditors require extra collateral. A lender may ask for additional collateral in order to appease investors or a credit committee. Sometimes creditors require additional collateral to keep a given loan at a constant interest level.
When securing a loan, issuers use collateral to increase the likelihood of repayment. If the borrower defaults on a loan, the lender would have the right to acquire the collateral in an attempt to pay off the remaining debt. If the lender lends additional funds on top of an already existing loan, then more collateral might also be required. Additional collateral can include cash, certificates of deposit, equipment, stock or letters of credit. Collateral itself is property or another asset that a borrower offers as a way for a lender to secure the loan. Since collateral offers some security to the lender should the borrower fail to pay back the loan, loans that are secured by collateral typically have lower interest rates than unsecured loans. For a loan to be considered secure, the value of the collateral must meet or exceed the amount remaining on loan. Offering additional collateral can help a borrower qualify for more favorable interest rates.
Common Types of Collateral
The most well-known form of collateral is mortgage collateral. For a mortgage, the collateral is the house purchased with the funds from the mortgage. If payments on the debt cease, the lender can take possession of the house through a process called foreclosure. Once the property is in the lender’s possession, the lender can sell the property to get back the remaining principal on the prior loan. The lender’s claim to the borrower's collateral, in this case, the house, is called a lien.
Additional Collateral and After-Acquired Collateral
Sometimes a lending institution requires more collateral than the borrower can put up to have more security for the loan. In this case, the borrower agrees to pledge all future property up to a certain amount as additional collateral for the loan. A lender may take additional collateral for a loan after the borrower and lender have already entered into a loan agreement. When a borrower has insufficient collateral for a loan but will be acquiring additional assets such as property in the near term, a lender may choose to issue the loan anyway. Then when the borrower receives those assets, they would be automatically collateralized.