Question:
Which one of the following is the purpose of collateral in a loan?
Which one of the following is the purpose of collateral in a loan?
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Remember:
\[
\boxed{\text{Collateral} = \text{Security against loan}}
\]
If the borrower fails to repay, the lender can sell the collateral to recover the loan amount.
Updated On: Jul 28, 2026
- To increase the interest for the lender
- To secure the loan for the lender
- To reduce paperwork for the lender
- To avoid repayment on the loan
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The Correct Option is B
Solution and Explanation
Step 1: Understand the meaning of collateral.
Collateral is an asset that a borrower pledges to the lender while taking a loan. It can be land, building, vehicle, livestock, jewellery, deposits or any other valuable property. The lender keeps the right to use this asset as security until the loan is repaid.
Step 2: Purpose of collateral.
The main purpose of collateral is to reduce the risk of the lender. If the borrower fails to repay the loan, the lender can sell the collateral and recover the loan amount. Therefore, collateral acts as a security against the loan.
Step 3: Why lenders ask for collateral.
Banks and other formal lenders generally ask for collateral before giving large loans because they need assurance that the loan will be repaid. This protects the lender from financial loss and makes lending safer.
Step 4: Eliminate the incorrect options.
Collateral is not taken to increase interest, so Option (A) is incorrect. It does not reduce paperwork, so Option (C) is incorrect. It also does not allow the borrower to avoid repayment; rather, it ensures repayment, so Option (D) is incorrect.
Step 5: Final conclusion.
Thus, the purpose of collateral is to secure the loan for the lender. \[ \boxed{\textbf{(B) To secure the loan for the lender}} \]
Collateral is an asset that a borrower pledges to the lender while taking a loan. It can be land, building, vehicle, livestock, jewellery, deposits or any other valuable property. The lender keeps the right to use this asset as security until the loan is repaid.
Step 2: Purpose of collateral.
The main purpose of collateral is to reduce the risk of the lender. If the borrower fails to repay the loan, the lender can sell the collateral and recover the loan amount. Therefore, collateral acts as a security against the loan.
Step 3: Why lenders ask for collateral.
Banks and other formal lenders generally ask for collateral before giving large loans because they need assurance that the loan will be repaid. This protects the lender from financial loss and makes lending safer.
Step 4: Eliminate the incorrect options.
Collateral is not taken to increase interest, so Option (A) is incorrect. It does not reduce paperwork, so Option (C) is incorrect. It also does not allow the borrower to avoid repayment; rather, it ensures repayment, so Option (D) is incorrect.
Step 5: Final conclusion.
Thus, the purpose of collateral is to secure the loan for the lender. \[ \boxed{\textbf{(B) To secure the loan for the lender}} \]
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