Hypothecation

Hypothecation means offering an asset as a collateral security to the lender whereby the ownership lies with a lender and the possession is enjoyed by the borrower. In a 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. Under hypothecation, 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 (asset under hypothecation) and then sell the asset to recover dues.

Example of Hypothecation

In the case of vehicle loans, the vehicle remains with the borrower but the same is hypothecated to the bank/ 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, hypothecation can be done for stocks and bills receivables.

Though pledge seems similar to hypothecation 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 hypothecation is for movable assets. Common examples include home loan in case of mortgage and vehicle loan in case of hypothecation

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.

The hypothecation deed is an agreement which contains standard features and rules; which usually cover the following points: Definitions, Insurance [to ensure good condition of the asset], Inspection rules [giving lender the right to inspect the asset as per agreed terms], rights and remedies of each party [in case of any default], security details marked for hypothecation, sale realizations, insurance proceeds, liability of each party, jurisdiction prevailing, marking of the assets etc. This deed protects the rights of both the parties to the contract.

Conclusion:

A hypothecation is a route by which borrower can raise funds by providing security (movable) as collateral and still get to use it since the possession remains with the borrower. This source of loan is given by the bank/ financer at a rate lower than the unsecured loan as it provides the sense of security to the lender.

The lender runs a risk as there may be instances where the borrower sells off the hypothecated asset without the knowledge of the lender; however periodic checks and proper clauses in the this deed can provide protection to a large extent to both, the borrower and the lender.

References:

Last updated on : July 12th, 2017
What’s your view on this? Share it in comments below.

Leave a Reply

Asset Financing
  • Convertible Bonds
    Convertible Bonds
  • Characteristics and Classifications of Letter of Credit
    Characteristics and Classifications of Letter of Credit
  • Venture Funding
    Venture Funding
  • Advantages and Disadvantages of Title Loans
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 122 other subscribers

    Recent Posts

    Find us on Facebook


    Related pages


    hypothication meaningsbi correspondent bankshedging finance definitiondebits and credits in bankingexpense vs capitalizebank loan advantages and disadvantagescoupon bond definitionmeaning of turnover ratioprofit maximization formulacapital lease accounting lesseeadvantages and disadvantages of breakeven analysisdefine merger and acquisitionpros and cons of issuing bondsproject irr calculationdebit the receiver and credit the giverdisadvantages of buying sharesdebtors turnover ratio meaningpbitformula dividend payout ratiocalculating wipwhat is bills of ladingmeaning of account payable and receivableconcept of debit and credit in accountingarbitrage pricing theory advantages and disadvantagesusance lc discountingaccount receivable turnover ratio formulasundries definition accountingadvantages and disadvantages of discounted cash flowdebenture defhow to improve solvency ratiodiluted earning per share formulacalculating inventory turnover ratevarious methods of capital budgetingirrevocable lcdefinition of owners equityredeemable debt formulacapitalization vs expenseraw material turnover ratiocredit card meaning in marathidifference between debit and credit accountinglessee versus lessorcapital budgeting techniques notesdebit definebalance sheet tutor2ucalculating turnover ratiodifference between personal real and nominal accountsexpenses meaning in hindiliability meaning in hindibep financepayback in financecalculate gross profit margin ratiounderstanding debits and creditsdefine restrictive covenantsoperational leasing vs financial leasinglimitations of ratio analysis in accountingtotal asset formulapayback period formulainventory turns definitioneps calculationshire purchase car loaninventory turnover measuresstatutory merger definitionshareholder wealth maximization modelcalculation of wacc examplewhat is operating leveragedifference between stakeholder and shareholderwhat does cash outflow meancapital rationing definitionperpetual preference sharespayback period exampleformula of roaaverage age of inventory formuladefine acid test ratiodisadvantages of inflation accounting