1.) COLLATERAL
If you borrow money from someone and you promise to pay them back, that is usually referred to as an unsecured loan. The only reason the person who loaned you the money (the creditor) knows you are going to pay them back, is because you promised to, usually in writing. Let’s suppose that the creditor is not willing to make the loan to you simply based on your promise to pay them back. The creditor may be willing to loan money to you, but wants you to loan them something of value for them to hold on to until you pay them back. Maybe it is a nice ring that was passed down to you. By the creditor holding on to your ring, you are motivated to pay them back quickly so you can get your ring back. That ring is called the collateral and under this circumstance the loan is secured by the ring.
2.) COLLATERAL CAN BE FORFITED
In a secured loan, the collateral is the security you give up while you pay the loan back. What happens if you do not pay the loan back in a timely manner? Usually, you forfeit the security. In other words, if you give up a valuable ring (the collateral) to ensure that you pay the creditor back, and you fail to pay the creditor back, the creditor gets to keep your ring. If the creditor then sells your ring and makes more than the original loan to you, the creditor gets to keep the difference.
Collateral does not have to be the entire thing. It can be a part of something. Let’s take the situation with the loan and the ring, but let’s suppose that the ring is really valuable in relation to the loan. Maybe, instead of taking the whole ring to make the loan, the creditor takes a 50% interest in the ring as collateral. When the loan is not paid, the creditor can then force you to sell the ring even though you really do not want to sell it. The creditor is entitled to be paid and since you gave an interest in the ring as collateral, the courts will allow the creditor to enforce his rights to that collateral and make you sell it.
3.) YOUR HOME IS COLLATERAL FOR HOME REPAIRS OR IMPROVENMENTS
Now let’s assume that you own a home. Also assume that you hire someone to do some work on your home. You now owe that person money for the work they did on your home. If you do not pay that person for the work they did on your home, under California law, they can assert a claim on your home. Your home then becomes the collateral to ensure that you pay them for the work they did on your home. The claim they assert on your home is called a lien.
Under this circumstance, you did not give the person who did the work on your home an interest in your home. The lien, or the security interest in your home, is given to the worker by the California Civil Code. They call this lien a Mechanic’s Lien. There are requirements that the worker has to follow to make this lien actually work. But it the worker follows these requirements; they can actually make you sell your house to pay them for this work. Therefore, it is important that you take Mechanic Liens seriously.
Not only can the worker force you to sell your home to get paid, but the filing of the lien is public. The lien is actually filed with the County Recorder. This may harm your credit and will likely preclude you from using the equity in your home as collateral in any other loans. Fortunately, the worker will usually give you notice of the fact that they are intending to file the lien prior to actually filing it. You will usually have the opportunity to pay them prior to having the lien filed. It is important to realize the ramifications of not paying a worker who does work on your home under California law.