A house is used as collateral for a mortgage loan. This was highlighted during the 2007 housing crisis when values dropped, leaving many in debt greater than the worth of their homes. Typically, a substantial down payment is needed to secure a mortgage.
A house is used as collateral for a loan. When obtaining a mortgage loan, the lender requires a physical asset as security. Thus, if the borrower defaults on the loan, the lender can take possession of the home to recover the debt. This was a particularly relevant issue during the housing crisis starting around 2007, where many homeowners faced bankruptcy due to the decline in home values, leaving banks with properties worth less than the loaned amount.
The practice of issuing zero-equity home loans, often paired with adjustable-rate mortgages (ARMs), exacerbated this issue as buyers, particularly those with limited financial understanding, were approved for home loans with no money down. When housing prices fell, these loans no longer seemed fail-proof—as they had been presumed—because the underlying collateral, the home, devalued significantly compared to the loan amount.
Lenders commonly require a down payment, often 20% of a home's purchase price, to ensure that the borrower has a significant financial stake in the property. A $100,000 house, for instance, would typically involve a $20,000 down payment with the remaining amount borrowed from the lender.