Pledge vs Hypothecation
Companies and individuals borrow funds for a number of reasons including, home loans, vehicle loans, education loans, loans for investment, expansion, business development and operational requirements. In order for banks and financial institutions to grant funds to borrowers, there needs to be some form of assurance that the borrowed funds will be repaid to the lender. This assurance is obtained when borrowers offer an asset (as collateral) of equivalent or higher value than the loan amount to the lender. In the event the borrower fails to meet his obligations, the lender then has means to recover any losses. The following article takes a closer look at pledge and hypothecation and highlights their similarities and differences.
What is a Pledge?
A pledge is a contract between the borrower (or party / individual that owes funds or services) and the lender (party or entity to which the funds or services are owed) where the borrower offers an asset (pledges an asset) as a security to the lender. In a pledge, the asset is delivered by the pledger (borrower) to the pledgee (lender). The lender will have legal possession of the pledged asset, and has the right to sell the asset in the event that the borrower is unable to meet his loan obligations. In order to recover the amount due to the lender, the asset is sold off, and the lender seizes the proceeds. In the event that there is a surplus remaining after the asset is sold and due amount is recovered, it is returned back to the pledger (borrower). However, the lender has limited interest with regard to the pledged asset, except for in the case of a loan default.
Pledges are frequently used in trade finance, commodity trading, and in the pawning industry.
What is Hypothecation?
Hypothecation is a charge that is created for assets that are moveable such as vehicles, stocks, debtors, etc. In hypothecation, the asset remains in the possession of the borrower. In the event that the borrower is unable to make due payments on his loan obligations, the lender first has to take action to possess the said asset before it can be sold off to recover the losses.
A very common example of hypothecation is car loans. The car or vehicle that is being hypothecated to the bank will be the property of the borrower, and in case the borrower defaults on the loan the bank obtains the vehicle and disposes it off to recover the unpaid loan amount. Loans against stocks and debtors are also hypothecated to the bank, and the borrower needs to maintain the right value in stock for the amount of the loan taken out.
Pledge vs Hypothecation
The main similarity between the two terms is that both pledge and hypothecation are related to borrowing funds from financial institutions. The lender needs some financial assurance that the borrower will repay his loan. In the event that the borrower is unable to pay his due loan, the lender needs some form of safety cushion that can be used to recover the losses. This is where the terms pledge and hypothecation come in. A pledge is a contract between the borrower and lender where the borrower offers an asset as a security to the lender. The lender will have legal possession of the pledged asset, and has the right to sell the asset in the event that the borrower is unable to meet his loan obligations. Hypothecation is a charge that is created for assets that are moveable such as vehicles, stocks, debtors where the assets remain in the possession of the borrower. When recovering due amounts from the borrower, the lender first has to take possession of the asset before disposing of it.
What is the difference between Hypothecation and Pledge?
• A pledge is a contract between the borrower (or party / individual that owes funds or services) and the lender (party or entity to which the funds or services are owed) where the borrower offers an asset (pledges an asset) as a security to the lender.
• The lender will have legal possession of the pledged asset, and the lender has the right to sell the asset in the event that the borrower is unable to meet his loan obligations.
• Hypothecation is a charge that is created for assets that are moveable such as vehicles, stocks, debtors, etc. In hypothecation, the asset remains in the possession of the borrower. In the event that the borrower is unable to make due payments on his loan obligations, the lender first has to take action to possess the said asset before they can be sold off to recover losses.