HYPOTHECATION MEANING
Hypothecation means offering an asset as collateral security to the lender. Herein, the ownership lies with a lender and the borrower enjoys the possession. In the case of default by the borrower, the lender can exercise his ownership rights to seize the asset.
It is usually done in a case of movable assets, for creating the charge against collateral for the loan given. The possession of the security remains with the borrower itself. Hence, if the borrower defaults on payments, the lender would have to first take possession of the security and then sell the asset to recover dues.
EXAMPLE
In the case of vehicle loans, the vehicle remains with the borrower but the same is hypothecated to the bank/Â financer. If there is any default by the borrower, the bank takes possession of the vehicle after giving notice and then sells the same. The loan account is credited with the sales proceeds of the asset to recover the dues towards the principal amount and interest amount. Any balance left thereafter shall be given back to the borrower. Apart from vehicles, hypothecated can be done for stocks and bills receivables.
Though pledge seems similar to hypothecated as both are types of charge created on movable assets; there lie some differences between pledge, hypothecation, and mortgage. Let us look at the differences to get a better idea of these terms.
PLEDGE V/S HYPOTHECATION
The possession of the asset remains with the lender in case of a pledge; while it remains with the borrower in case of hypothecation. Common examples include the gold loan in case of pledge and vehicle loan in case of hypothecation.
MORTGAGE V/S HYPOTHECATION
The possession remains with the borrower in both these cases, however, mortgages are usually for non-movable assets while hypothecated is for movable assets. Common examples include the home loan in case of mortgage and vehicle loan in case of hypothecated.
ALTERNATE ASSET FOR HYPOTHECATION
It can also be done for investments/stocks. This is a common practice in stock trading, better known as, margin lending. In such a case, the buyer, buying shares on margin, places his existing shares as collateral with the brokerage firm. These shares can be sold by the brokerage firm if the buyer faces the margin call. A margin call is received when the value of securities bought decreases more than a certain limit or the account value reduces beyond a certain limit.
DOCUMENTATION
This activity usually requires an agreement to be made and is known as the hypothecation deed.
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