What happens if a borrower fails to repay a loan secured by collateral?

What happens if a borrower fails to repay a loan secured by collateral?

• A. The bank can adjust the interest rate
• B. The bank will seize the collateral asset
• C. The borrower is automatically granted a new loan
• D. The collateral is returned immediately

Answer: (B)

When a borrower fails to repay a loan that is secured by collateral, the lender has the legal right to seize the collateral asset. This is known as foreclosure, where the lender repossesses the asset that was pledged as security for the loan. The collateral acts as a guarantee for the bank, ensuring that they have a means to recover losses if the borrower defaults. For instance, if someone takes out a loan to purchase a car and the car serves as collateral, if the borrower fails to make the necessary payments, the lender can take back the car to mitigate their financial risk. This mechanism protects lenders by providing a way to recoup funds, as the value of the collateral helps to reduce potential losses incurred from the non-payment of the loan. In contrast, adjusting the interest rate, automatically granting a new loan, or immediately returning the collateral do not occur as a consequence of defaulting on the loan. These options do not align with standard lending practices where repayment and the rights to collateral are foundational elements of the lending agreement.

When a borrower fails to repay a loan that is secured by collateral, the lender has the legal right to seize the collateral asset. This is known as foreclosure, where the lender repossesses the asset that was pledged as security for the loan. The collateral acts as a guarantee for the bank, ensuring that they have a means to recover losses if the borrower defaults.

For instance, if someone takes out a loan to purchase a car and the car serves as collateral, if the borrower fails to make the necessary payments, the lender can take back the car to mitigate their financial risk. This mechanism protects lenders by providing a way to recoup funds, as the value of the collateral helps to reduce potential losses incurred from the non-payment of the loan.

In contrast, adjusting the interest rate, automatically granting a new loan, or immediately returning the collateral do not occur as a consequence of defaulting on the loan. These options do not align with standard lending practices where repayment and the rights to collateral are foundational elements of the lending agreement.