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WHAT IS 'Side Collateral'

Side collateral is a pledge that partially collateralizes a loan. The pledge can be a physical asset, financial asset or personal guarantee. While physical or financial assets can be assigned an underlying price or value, personal guarantees depend solely on the character of the borrower. Most commercial lenders will not accept side collateral as a means to secure a loan or line of credit.

BREAKING DOWN 'Side Collateral'

Side collateral refers to a situation in which a borrower partially 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 level of reassurance against default risk, and may also help a borrower receive a loan they were otherwise unable to obtain with less desirable credit history.

When accepting side collateral, the borrower typically signs a security agreement that gives the lender legal authority to sell or dispose of the collateral if the borrower does not repay the loan or debt obligation. The borrower can also file a security agreement with a public records office as the financing agreement between both parties.

Why Collateralization Matters

Collateral refers to the use of property or other assets a borrower offers as a way for a lender to secure the loan. 

Side collateral does not fully cover the whole amount of a loan. For example, a borrower seeking to obtain a $10,000 loan may pledge $1,000 as side collateral. Under this agreement, the lender can sell the property should the borrower fail to pay his obligation. This pledge can be in either a physical or financial asset or in cash. Some of the most common types of collateral used in collateralized loans include real estate, automobiles, art, jewelry and securities.

Investors commonly use securities as collateral, and the government regulates investment type of collateral use, which is primarily overseen by the Federal Reserve. Businesses also often use collateral in their credit lending deals. Businesses use all types of collateral for debt offerings, including bonds, which may include terms to specific secured assets as collateral such as equipment or property. This type of collateral is pledged for the repayment of the bond offering in the event of default. If the borrower defaults, the lender can seize the collateral property for repayment to investors. The increased level of security offered to a bondholder typically helps to lower the coupon rate offered on the bond which can decrease the cost of financing for the issuer.

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