Collateral is something valuable you pledge as a guarantee when borrowing money, with the understanding that the lender can take it if you don't repay the loan. When someone takes out a car loan, the car itself serves as collateral: if they stop making payments, the bank can repossess the vehicle. When a homeowner gets a mortgage, the house is collateral for that loan.

Think of collateral like leaving your favorite baseball glove with a friend when you borrow their bike. Your friend knows you'll bring the bike back because you want your glove returned. Banks and lenders use the same principle, except with houses, cars, or other valuable property.

Collateral makes lending less risky: if you don't repay what you borrowed, the lender has something of value to claim instead. This is why loans with collateral (like mortgages) often have lower interest rates than loans without it (like many credit cards). The lender has protection, so they'll accept a smaller profit.

You might also hear collateral used as an adjective in phrases like “collateral damage,” which refers to unintended harm that happens alongside the main event, such as when nearby buildings are damaged during a construction blast.