Define Collateral Agreement

Collateral agreements allow entities to use extra funds for specific purposes.

Many different types of contracts are used when two different entities exchange funds. One type of contract is known as a collateral agreement. There are several different types of collateral agreements, depending on circumstances. Some collateral agreements govern the actions between a broker and a bank. Others are used by the Internal Revenue Service for tax debts that are collected from taxpayers.

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Definition

A collateral agreement does not necessarily name a specific number as a payment that is to be given, either to a broker or the government. Instead, collateral agreements are used as part of other contracts that refer to funds in addition to a particular sum set out. In the case of the IRS, the collateral agreement allows it to take extra money based on taxpayer circumstances. When dealing with banks, it gives brokers the ability to borrow funds to purchase securities.

Purpose

A collateral agreement is useful when funds must be paid, but there is no specific current factor to decide how much money must be given. The IRS may use such agreements to collect tax debts that go beyond specific amounts, so they can be ensured full payment of the agreed debt. Banks may use a collateral agreement if they do not know how much money they will let a broker borrow and do not want to continue approving each specific request.

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Banks and Brokers

When the agreement is made between a broker dealing in securities and a lending facility, it is known as a general loan and collateral agreement. This creates an open-ended agreement that allows the broker to borrow funds from the lender organization for specific tasks on a continuous basic. Most brokers use these collateral agreements to borrow money for margin accounts for their clients or for underwriting purchases.

Government

When taxpayers uses collateral agreements, they are giving the IRS the ability to collect funds in addition to an amount of money agreed upon in the payment of debts. This can occur when the taxpayer cannot pay taxes and instead offers to pay a lower tax amount immediately, while signing a collateral agreement that allows the IRS to collect the remaining difference in future years.

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Future Income

When a taxpayer makes a collateral agreement with the IRS, it is usually for money that is taken from future income. Different collateral agreements collect different percentages of future income until the debt is fully paid off. The IRS typically designs collateral agreements, so the taxpayer will have enough future income left to pay off all living expenses.

Collateral Loan Agreements

Another classification of collateral agreements is the collateral loan agreement. These agreements are made between banks and businesses or other private entities regarding loans. Many types of loans, such as mortgages and car loans, have some form of collateral agreement in the contract, but the words are not always used, and it is not always considered a separate document. A collateral loan agreement is usually made for a specific type of loan that is given to a business. The business provides real estate, funds, equity, life insurance or some other type of investment as collateral in return for a loan from the bank to buy a property or start a new project. These collateral loan agreements are rarely made with individuals.

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Government Transactions

A collateral agreement is also made between banks and smaller governing entities, such as city councils and sometimes state governments. These collateral agreements are similar in nature to the agreements made between banks and brokers, except that the agreement is made with a state treasurer and concerns investment into securities by the government.

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