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The Difference Between Collateral And Security

By on May 14, 2019

When we talk about assets that are pledged to a lender to secure a loan, we often refer to the assets as collateral or security.

It’s almost as if the two words refer to the same thing and can be used in sentences interchangeably.

This is partly due to terms like “secured loan” or “loan secured by property” often being used when the topic of home mortgages are being discussed.

For example, security instrument is also a term meant to represent an asset (like a house) being used to secure a loan.

So people understandably use the term “security” to mean the real property being pledged as a house being secured would be the “security”.

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There is really no problem when using either terms in conversation as long as all parties understand what they are meant to convey.

However in language and legal terms, collateral and security have different meanings.

Collateral

A collateral refers to any assets that are used by a borrower to secure a loan from a lender.

This means that should a home loan be approved and the borrower defaults, then the lender has the right to commence legal proceedings to foreclose the house and auction it off to settle the debts.

This is the same with other assets that are collateralized for a loan.

Some common examples of collateral are cars, antiques, art, land, etc.

Security

A security also refers to assets used by a borrower to secure a loan.

The difference this time, is that these assets are financial assets like bonds, stocks, equities, etc.

This means that real estate by definition is not a security in a mortgage. REITs on the other hand, can be a security.

What does this mean?

The biggest takeaway from all these is that a security is a collateral, but a collateral is not necessarily a security.

Real estate and a portfolio of stocks can both be pledged to a bank as collateral for a secured loan.

But real estate is not a security, and the portfolio can be described as both a collateral and a security.

Using a portfolio of equities as collateral can have it’s advantages against property.

And this is that they have fluctuating value and might even have dividends which the borrower would financially benefit from.

The argument against this is that a house can also appreciate in value and enable an owner to collect rental income.



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