What is the primary function of collateral?

The primary function of collateral is to secure repayment of a loan. When a borrower provides collateral, they are offering an asset that the lender can claim if the borrower fails to repay the loan. This reduces the risk for the lender, as they have a tangible resource to fall back on if the borrower defaults. The presence of collateral can make it easier for borrowers to obtain loans since lenders are more willing to extend credit when they have security backing the loan agreement.

This security feature can also influence the terms of the loan, potentially allowing for lower interest rates or larger loan amounts compared to unsecured loans. By effectively mitigating the lender's risk, collateral plays a crucial role in lending agreements and financial transactions.