What does it mean when a loan is secured by collateral?

When a loan is secured by collateral, it means that the lender has a claim on specific assets provided by the borrower in case the borrower fails to repay the loan. This arrangement serves as a safety net for the lender because it reduces the risk associated with lending money. If the borrower defaults on the loan — that is, fails to make the agreed-upon payments — the lender has the legal right to seize the collateral to recover their losses. This can include items such as property, vehicles, or savings accounts, depending on the terms of the loan agreement.

The presence of collateral gives lenders greater confidence when extending credit, which is why it often leads to more favorable loan conditions, such as lower interest rates. However, the key aspect of secured loans is the lender's ability to reclaim the collateral if the borrower does not fulfill their repayment obligations. This enhances the lender's security compared to unsecured loans, which carry no assets as protection against default.