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Hypothecation

Hypothecation is when a borrower uses property or assets as collateral for a loan without transferring possession. It allows borrowers to retain ownership while easing lender risks. A hypothecation agreement specifies the terms, with the asset serving as security until the loan is repaid. Common uses include vehicle, equipment, and commercial property financing. Key differences from mortgages and pledges involve possession of the collateral by the borrower versus the lender. Indian law defines and regulates hypothecation's creation and removal.

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270 views

Hypothecation

Hypothecation is when a borrower uses property or assets as collateral for a loan without transferring possession. It allows borrowers to retain ownership while easing lender risks. A hypothecation agreement specifies the terms, with the asset serving as security until the loan is repaid. Common uses include vehicle, equipment, and commercial property financing. Key differences from mortgages and pledges involve possession of the collateral by the borrower versus the lender. Indian law defines and regulates hypothecation's creation and removal.

Uploaded by

anu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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All you need to know about hypothecation

February 16, 2022


153

Table of Contents
 Introduction
 What is hypothecation?
 When are hypothecation agreements used?
 Hypothecation in investing
o 1. Reduction of down payment
o 2. Retain the title
o 3. Greater security for lenders
 Difference between hypothecation, pledges, and mortgage
 Indian laws covering hypothecation
 Formalities for creation of hypothecation
 How is hypothecation removed?
 Conclusion
 References
Introduction
Goods financed by banks in India are often hypothecated to the bank as security/ collateral till the loan
covering it is repaid by the borrower. Hypothecation is used when a debtor wants to obtain a loan and
use a certain property or asset as a security or collateral. It can help reduce mortgage fees and interest
and help those who may not look their best on paper to obtain a loan. This article deals with everything
you need to know about hypothecation. If you are someone who wonders if hypothecation is the best
route for you to secure financing, this article is for you!

What is hypothecation?
Hypothecation generally means a fixed or floating charge on certain types of immovable properties and
tangible movable properties, whether existing or future, which is created by a security provider in favour
of a lender without actual delivery of possession of the underlying asset to the lender. Hypothecation
comes into the picture when an asset is pledged as collateral to secure a loan. Income generated by the
asset such as title, possession or ownership rights, etc is not given up by the owner of the asset.
However, if the terms of the agreement are not met, the lender can seize the asset.
For example, a rental property may undergo hypothecation as collateral against a mortgage issued by a
bank. The bank has no claim on rental income that comes in while the property remains collateral.
However, the bank may seize the property if the landlord defaults on the loan.
You can ease your lender’s concerns and receive mortgage approval by offering other assets as
collateral. You do entertain the risk of losing your piece of collateral when you are entering into a
hypothecation agreement, whether it is for commercial or residential investments. Therefore, you need
to be prepared to lose the asset if you are unable to repay your lender.
When are hypothecation agreements used?
The hypothecation agreement between the borrower and the lender isn’t a verbal agreement. Rather it
is done through a document called hypothecation deed. A hypothecation agreement or hypothecation
letter specifies the terms of the hypothecation and conclusively determines the rights and liabilities of
parties to the agreement. The most common use of hypothecation is in the financing of cars and
motorcycles in India as well, as while purchasing commercial real estate property. Often, hypothecation
is used when a debt is to be secured and the creditor asks for collateral or security of sorts to help
mitigate his risk. Hypothecation is also widely used in consumer and business finance, in the financial
industry as well as in the investment market. 
Hypothecation in investing
Hypothecation is most commonly used for real estate investments. Lenders often require additional
collateral with commercial real estate investments. These types of investments and properties can pose
a higher risk because the loan payment relies on the success of a commercial business. The lender may
request collateral of higher monetary value depending on the perceived value of the investment
location or type of property. There are several reasons why you will want to make a hypothecation
agreement instead of other agreements. The reasons include the following:
1. Reduction of down payment
The amount of down payment that a borrower owes can be reduced by hypothecating an asset because
the borrower is pledging a high-value asset to guarantee his loan, rather than in a traditional mortgage,
which uses loan-to-value ratios and credit score to vet a borrower. Hence, borrowers choosing to
hypothecate an asset to secure a loan may be eligible for reduced down payments and this can make it
easy to secure financing.
2. Retain the title
Borrowers can retain the title, i.e. total ownership rights of their hypothecated assets. If you are sure
that you will be able to pay off your loan, you don’t need to worry about the possibility of a third party
holding the title to your asset.
3. Greater security for lenders
Hypothecation provides security for lenders on high-risk loans, especially for commercial mortgages
where the loan payment relies on the success of a commercial business.

Difference between hypothecation, pledges, and mortgage


Hypothecation is creating a charge against the security of movable assets. The possession of the security
remains with the borrower. In case of default by the borrower, the lender (i.e. to whom the
goods/security has been hypothecated) will have to first take possession of the security and then sell the
same. For example, cars/vehicles remain with the borrower but the same is hypothecated to the bank or
financer. In case, the borrower defaults, the bank takes repossession of the vehicle after following due
process of law. Generally, hypothecation also covers loans against stock and debtors. Sometimes,
borrowers may, without authorisation, sell goods hypothecated to a bank in which case a bank may
convert the goods to a pledge.
Pledge is used when the lender (pledgee) takes actual possession of assets (i.e. certificate, goods).
Pledge is movable security and the possession of the security remains with the lender (i.e. the pledgee).
In this case, the pledgee retains the possession of the goods until the pledgor (i.e. the borrower) repays
the entire debt amount. In case there is default by the borrower, the pledgee has a right to sell the
goods in his possession and recover outstanding dues. Some examples of pledging are gold/jewellery
loans, advance against goods/ stock, advances against National Saving Certificates, etc.
A mortgage is immovable security, which may include land, buildings, factory premises, godown/
warehouse, or anything that is attached to the earth or something permanently fastened to anything
that is attached to the earth. The possession of the security in the mortgage usually remains with the
borrower. Hypothecation is movable security (e.g. stocks, accounts receivables, small machines, etc) and
the possession of the security remains with the borrower. The tenure of hypothecation is generally
shorter than the tenure of home mortgage loans, like in the case of the tenure of a vehicle, and it is
renewable after a year or half-year. In a mortgage, loans are of longer tenure as compared to loans
against hypothecation and the tenure varies from 10 to 20 years.
Indian laws covering hypothecation
Previously, hypothecation was not defined for a long time under Indian law and it was more on the basis
of practice and usage. However, now under the Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interests Act (SARFAESI), hypothecation is defined as “a charge in or upon
any movable property, existing or future, created by a borrower in favour of a secured creditor without
delivery of possession of the movable property to such creditor, as a security for financial assistance,
and includes floating charge and crystallization into fixed charge on movable property.”
Formalities for creation of hypothecation
In hypothecation, a “deed of hypothecation” is executed by the security provider in favour of the lender.
The charge created under the deed of hypothecation is governed by the terms of the document, which
provides in detail the powers and provisions safeguarding the interest of the lender. Hypothecation over
a motor vehicle must be noted on the registration certificate of the motor vehicle.
The other formalities for hypothecation include payment of appropriate Stamp Duties as per rates in
each state and in case of companies, filing with ROC will be required. After 2016 and the formation of
CERSAI (under SARFAESI) Central Registry of Securitisation and Asset Construction and Security Interest
of India, a government body set up for such purpose, it is mandatory to file creation, modification, or
satisfaction of security interest in hypothecation of plant and machinery, stocks, book debts, and
receivables.
How is hypothecation removed?
You can remove the hypothecation by paying off the entire loan amount. The bank will issue a No
Objection Certificate (NOC) to you. This document will state that no dues are pending. You can submit
the copies to the Regional Transport Authority and the insurance company so that the registration and
insurance can be converted in your name instead of the bank’s name.
Conclusion
Hypothecation is a way in which the borrower can raise funds by providing movable security as
collateral. The borrower still gets to use it since the possession usually remains with the borrower
himself. This loan (hypothecation) is provided by either the bank or the financer at a rate lower than the
unsecured loan as it provides a sense of security to the lender. However, the lender takes a risk as there
may be instances where the borrower sells off the hypothecated asset without the knowledge of the
lender. To provide protection to a large extent to both, i.e., the borrower and the lender, the lender
shall conduct periodic checks and the parties shall add proper clauses in the hypothecation agreement.
References
1. https://www.investopedia.com/terms/h/hypothecation.asp
2. https://www.upnest.com/1/post/hypothecation-agreement/
3. https://www.masterclass.com/articles/hypothecation-real-estate-explained#3-advantages-of-
hypothecation-agreements

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