Prime security is an asset acquired by a borrower under a loan and it is the same asset that is offered to the lender as a security for the financed amount. The collateral security is one where the lender asks the borrower to provide extra security in addition to the prime security.
The situation of lender asking for collateral security arises when the lender feels that the prime security is not adequate to cover the dues in case of default by the borrower. The collateral security offered need not necessarily be in the name of borrower. The assets in the name of the guarantor/s can also be offered as collateral security.
Illustrations of prime and collateral securities:
You have availed a housing loan of Rs.50 lakh from a bank to purchase a residential flat. The bank asks for mortgaging of the same flat financed by it as a security. Thus the flat mortgaged by you against which bank has financed is called prime security.
Let us take another example of a residential flat mortgaged to a bank for a different purpose. The bank sanctions a term loan of Rs.1.50 crores to an Industrialist for the purchase of machinery worth 2.00 crores for his factory. The sanction terms of the loan put a stipulation that the industrialist has to offer the residential flat in his name worth Rs.1.00 Crore as a collateral security for the above bank finance. Here, the machinery worth Rs.2.00 crore purchased through bank loan is the prime security and the residential flat worth Rs.1.00 crore is the collateral security offered to the bank.
Related article: Difference between first charge and second charge explained