Hypothecation is the practice of using collateral to secure debt.
In this process a lender receives an asset which is offered to him/her as a collateral security and it is largely done in the case of assets that are movable in nature for the purpose of establishing the charge against collateral security for a particular loan. Here, the owner of the asset does not give up title, possession, or ownership rights, such as income generated by the asset.
For example, in case of a car loan, the loan is secured against car as collateral security . In this case, if any failure is made to repay the loan the lender can repossess the car.
The loan can be availed easily at a lower interest rate in case of hypothecation as compared to unsecured loan since it provides security to the lender because of the collateral pledged by the borrower.
WHAT IS HYPOTHECATION AGREEMENT ?
It is an agreement between a borrower and a lender where by the borrower pledges asset as collateral on a loan without the lender taking possession of the collateral. It is usually done through a document called hypothecation deed.
Both the parties must abide by the terms & conditions mentioned in the agreement since on the basis of this deed, the whole agreement is done and adhered to.
The deed usually includes the following points –Definitions, insurance, Inspection rules, rights & remedies of each party, insurance proceeds, sales realizations, jurisdiction etc.
BENEFITS OF HYPOTHECATION-
Hypothecation offers many advantages some of which are as follows-
- OWNERSHIP : Since a borrower can keep the ownership of the movable property with him , hypothecation is a much better option for new businesses or startups.
- LOWER RATE OF INTEREST :- Hypothecation offers a sense of security to the lender since he can seize the asset in case of default on repayment of loan hence the loans are offered at lower interest rates.
- EASY AVAILABILITY : The nature of the loan against hypothecation is secure. Hence, the competition amongst lenders increases as they all want such types of loans. Therefore, these loans are easily available.
Thus , in simple words hypothecation occurs when the asset is provided as collateral in order to obtain a loan without giving the title rights, possession, or any other income generated by the asset.