Risk Management Basics
- Fixed Income
- Credit Analysis | What Credit Analyst Look for? 5 C's | Ratios
- Equity Research vs Credit Research - Know the difference!
- Yield Curve Slope, Theory, Charts, Analysis (Complete Guide)
- Bond Pricing
- Coupon Bond
- Coupon Bond Formula
- Zero Coupon Bond
- Duration Formula
- Coupon Rate Formula
- Carrying Value of Bond
- Sinking Fund Formula
- Coupon Rate of a Bond
- Convertible Securities
- What are Treasury Bills?
- Repurchase Agreement
- Treasury Bills vs Bonds
- Coupon vs Yield
- Coupon Rate vs Interest Rate
- Credit Rating Process | A Complete Beginner's Guide
- Asset Backed Securities (RMBS, CMBS, CDOs)
- Loss Given Default - LGD | Examples, Formula, Calculation
- Top 7 Best Fixed Income Books
- ABS and MBS Index | Complete Beginner's Guide
- Top 10 Best Treasury Management Book
- Top 10 Best Credit Research Books
- Convexity of a Bond | Formula | Duration | Calculation
- Payment in Kind Bond | PIK Definition | Interest | Example
- Subordination Debt | Meaning | Example | Types | Risks
- Top 10 Best Books - Bonds Market, Bond Trading, Bond Investing
- Bonds vs Debentures
- Secured vs Unsecured Loan
- Bills of Exchange vs Promissory Note
- Bills of Exchange | Meaning | Examples | Top Features
- Promissory Notes
- Secured Loans
- Unsecured Loans
- Subordinated Debt
- Fallen Angel
- Bond Equivalent Yield Formula
- Junior Tranche
- Credit Analyst Interview Questions and Answers
- Debt Covenants | Bond Covenant Examples | Positive & Negative
- Negative Covenants (Restrictive)
- Sinking Fund
- Bond Sinking Fund
- Negotiable Instruments
- Credit Spread
- Bond Pricing Formula
What is Hypothecation?
Definition – Hypothecation is a term used wherein the borrower can pledge his movable assets as a loan while retaining the interest and the ownership of the assets.
It is almost similar to the mortgage, but there’s a thin line between Mortgage and Hypothecation.
- In hypothecation, the assets are not immediately transferred to the lender. It does remain in the interest of the borrower. Now if the borrower is unable to pay the money, then the lender would take the possession of it. And then maybe the lender would sell it off to get back the money.
- There is another difference between the two. In hypothecation, the property that is at stake isn’t immovable property, but movable property like car, vehicle, accounts receivable, stocks etc.
- Also, in this the amount of loan is also much lower than the home loans. So, the terms and conditions are not as stringent as in the mortgages.
Let’s take a hypothecation example to illustrate the concept. Let’s say that you have decided to take a vehicle loan for your business. This would be used for your business. So, you went ahead and approached a bank.
The bank said that they will offer you a loan, but you need to take the loan under hypothecation. The bank further explained that the vehicle that you want to take would be used by and owned by you only. The bank will help you will assist in the loan. But the vehicle that you own would be hypothecated and if you aren’t able to pay the amount due to the bank within a certain period of time, the vehicle would be possessed by the bank.
You agreed to the proposal of the bank and the bank has offered you a loan.
What is Hypothecation Agreement?
The hypothecation agreement between the borrower and the lender isn’t done in verbal agreement. Rather it is done through a document called hypothecation deed.
Here is the list of things that are included in the hypothecation agreement –
- Insurance to ensure that the asset is in great condition.
- The lender’s rights to check out the asset before giving her/his nod.
- The rights, conditions, and terms that should be adhered by both of the parties.
- The security
- Insurance proceeds.
- Realizations from sales.
- The liability that lies on each party.
- Jurisdiction etc.
This deed is so very important since on the basis of this deed the whole agreement is done and adhered to. And two parties are equally responsible to abide by the terms and conditions mentioned in the hypothecation agreement.
Benefits of Hypothecation
In this, borrower has many advantages. Let’s have a look at them one by one –
- Ownership: This is a much better option for an individual who has just been starting out in business or career. Of course, there are terms and conditions that need to be followed, but one of the most important advantages is ownership. As a borrower, you can keep the ownership of your movable property and at the same time, you will get assistance from the bank for the loan. The only condition is you need to pay the due amount on time.
- Lower interest rate: Since there is an option of possessing the movable property if the money isn’t paid on time, the bank/financier charges less interest rate. Two reasons are responsible for charging lower rates. Firstly, the option of possessing the vehicle offers the lender a sense of security that the money would be paid back. Secondly, it is not an unsecured loan as there would be the signed hypothecation agreement between two parties.
- Small loans: Unlike a mortgage, this is done for the small amount of loans. As a result, it’s easy to use and easy to pay off. As a business owner, it’s a great opportunity and often this is used more than mortgage loans.
This has been a guide to What is Hypothecation along with practical examples. Here we also discuss Hypothecation agreement and its benefits. You may also have a look at the following fixed income articles –