When using a mortgage to buy a home, the lender needs to be confident that you will be able to repay the loan. While a strong credit score, steady income, and a good track record of managing debt provide reassurance, the lender also depends on the collateral securing the loan—the home you’re purchasing—to make their approval decision.

What is collateral for a mortgage?

Collateral is an asset that a borrower provides as security for a loan or debt. For a mortgage (or a deed of trust, which is used in some states), the collateral is typically the property you are buying with the loan.

When you secure financing, a lien is placed on the property. This lien gives the lender the right to seize the collateral if you fail to repay the loan according to the terms of the contract. Once the loan is fully repaid, the lender removes the lien and no longer has a claim on the property.

Regardless of what you use as collateral or how you plan to use the borrowed funds, the concept remains the same: It serves as a guarantee to secure the loan.

How does mortgage collateral work?

In the case of a mortgage, the home itself, also known as “real property,” serves as collateral.

When deciding whether to approve your loan, the lender will order an appraisal to confirm that the property is worth the amount you propose to pay. If the appraisal indicates that the property is undervalued, the lender may deny the mortgage, as the collateral does not justify the risk.

If you fail to repay the mortgage and cannot reach a resolution with the lender, the lender may foreclose on the home, resulting in the loss of your collateral.

There are different rules for how a lender can recover losses, depending on whether the mortgage is a recourse or non-recourse loan:

  • Recourse Loan: With a recourse loan, the lender can pursue additional assets beyond the home or take legal action to garnish wages if you default. This means you could lose your home as well as future income and other valuable assets.
  • Non-Recourse Loan: With a non-recourse loan, the lender can only recover the value of the home and must absorb any difference between the property’s value and the remaining loan balance. While you still lose the home, you won’t risk losing other assets or income.

Examples of collateral in the mortgage process

  • Buying a Home: When you purchase a home with a mortgage, the home itself serves as collateral for the loan. If you miss a number of payments—usually three to six months, though it can be as few as one—you will be considered in default. This could lead to foreclosure, where the lender reclaims the home. To avoid this, it’s crucial to stay current on your mortgage payments.
  • Home Equity Line of Credit (HELOC) or Home Equity Loan: You can use the equity you have in your home as collateral for a HELOC or a home equity loan to cover other expenses. While HELOCs and home equity loans have some differences, they both require putting your home at risk as collateral.
  • Starting Your Own Business: If you’re planning to start a small business, you may be able to use your home as collateral to secure a small business loan. This can provide the financial support needed to get your new venture off the ground.

Difference between collateral and mortgage

You’ll often encounter the terms “collateral” and “mortgage” together, but it’s important to understand their distinct meanings.

A mortgage is a specific type of loan used to finance the purchase of a property. Collateral, on the other hand, is any asset that secures a loan.

When you take out a mortgage, the property you are buying serves as the collateral. Essentially, the mortgage represents the debt, while the collateral—the property—demonstrates your commitment to repaying that debt.

Other types of collateral loans

  • Auto Loans: With an auto loan, the vehicle itself serves as collateral for the loan. If you fail to make your payments, the car can be repossessed by the lender.
  • Secured Personal Loans: These loans require an asset—such as your home, a cash account, or a car—to act as collateral. They generally have more flexible eligibility criteria compared to unsecured personal loans but may offer lower borrowing limits.
  • Secured Credit Cards: A secured credit card requires a security deposit, which typically determines the card’s credit limit. These cards are often used to build or improve credit. After demonstrating responsible use over time, the issuer may refund your deposit and upgrade you to an unsecured card.
  • Securities or Portfolio Line of Credit: This type of credit line uses investments in a brokerage account as collateral. It offers a revolving credit line with a variable interest rate, and you repay at your own pace. If the value of your investments declines, you may need to provide additional cash to cover your debt, or the broker may sell some of your securities to protect the loan.