What does the term 'collateral' refer to in a secured loan?

In the context of a secured loan, 'collateral' specifically refers to the asset that secures the loan. This asset serves as a form of protection for the lender in case the borrower fails to repay the loan. By having collateral, the lender can claim the asset to recover some or all of the outstanding debt if necessary. Common examples of collateral include real estate, vehicles, or other valuable items.

Understanding the role of collateral is crucial because it reduces the lender's risk and often allows borrowers to secure loans at lower interest rates compared to unsecured loans, where no asset backs the obligation. This concept highlights the importance of the asset in the lending arrangement and how it serves to mitigate potential losses for the lender.