What is collateral?

Collateral is like a promise you give to someone so they’ll lend you something.

Imagine you want to borrow your friend’s favorite toy to play with during recess. But your friend says, “Okay, but I need something from you in return, just in case you break it or forget to bring it back.” That something you give them is like collateral, it’s a backup plan that makes the deal fairer for both sides.

If you borrow your friend's toy and promise to give them your favorite candy in return, that candy is the collateral. If you don’t bring back the toy, your friend can keep the candy instead.

It’s like when you go to a store and borrow a bike to ride around the block, they might ask for your name or address as collateral so they know where to find you if you don't return it.

In bigger situations, like with banks, people use things like houses or cars as collateral. If they can’t pay back their loan, the bank gets the house or car instead.