What does hypothecation mean?

Hypothecation is a tool you can use to secure a loan at a low cost. It is a method of taking out a loan that provides assurance to the lender, thereby reducing the interest rate you pay.

In this post, we answer the question: What is Hypothecation? For more information, read.

What does hypothecation mean?

Hypothecation Loan Meaning in Hindi

Hypothecation is when you agree to use a property as collateral when you sign up for the loan.

For example, when you mortgage your house, your house acts as a collateral. If you fail to make the repayment, the lender – usually a bank – can take it back and recover your losses.

Hypothecation does not mean that you give up your ownership rights. When the lender seizes the property in the event that you fail to repay as per the agreement, they cannot claim the income from the property. For example, if it is a rental property, they do not get the money earned on it. However, they can sell it or increase their equity stake.

Unsecured loans are different. Lenders cannot automatically seize assets as part of the loan agreement, so interest rates are usually higher. Hence the cost of a personal loan is higher than that of a mortgage loan. However, there are still penalties for late payments, including a strike on your credit score.

Types of Hypothecation in Hindi

Since hypothecation is just a general term to describe any situation in which a borrower exchanges collateral for lower interest rates, it pops up regularly. In this section, we’ll list some use cases:

1. Hypothecation in Mortgage

Hypothecation is related to meaning collateral, not ownership. So, when you take out a mortgage, you own the property: your name is on the title deed, and you can modify the property as you see fit.

However, it still has an obligation attached to it: mortgage repayment. If you do not repay the loan, the lender has the right to seize the property and sell it to meet the loss. When this happens, it is called foreclosure. Even if your name is on the title deed, the lender can still take possession.

On the other hand, if you pay cash for a property, you will not have a hypothecation, and you will be the absolute owner of your property.

2. Hypothecation in Investment

Investors sometimes borrow money if they find lucrative business opportunities.

For example, when traders sell for short periods, they automatically accept that they will need to sell their securities if the account value falls below a certain level. When a margin call occurs, the investor agrees to sell the securities regardless of the loss. This is Hypothecation with Securities as Collateral.         

3. Hypothecation in Real Estate

Commercial real estate investors also often use hypothecation in a similar way to make payments to residential property owners. When investing in an office building, retail unit, or production facilities, lenders may ask them to hold a property to guarantee the loan.

Interestingly, it is not necessarily the property they are using the loan to buy. This could be a house or other real estate property that they own.

4. Other Types of Hypothecation

There are many other instances where you may encounter hypothecation, but they all work on the same principle. You exchange the asset collateral for a lower interest rate on the amount borrowed.

Auto loans are a good example. These are economical because hypothecation agreements stipulate that the lender can take back the vehicle if you fail to make repayment.

It’s very similar to business loans: if you don’t make payments on time, the lender can seize the equipment you bought with the loan as collateral.

Why does Hypothecation matter?

Hypothecation, as discussed above, reduces the cost of the loan. Without it, mortgaging or taking out a loan to buy a car would be significantly more expensive, as lenders charge very high interest rates to cover their risks.

Hypothecation is also helpful when prioritizing your budget and expenses. If you took out a lot of debt, it’s usually prudent to pay back the mortgage first and avoid forfeiture.

Unfortunately, unsecured loans become more expensive due to higher interest rates. So if you focus exclusively on paying installments on Hypothecation Loans, you may end up with unmanageable loans from unsecured loans.

What is Rehypothecation?

Prior to the 2008 financial crisis, revaluation in investments was a common practice. Banks and investors will use the assets of their customers as collateral to back their transactions. This practice allowed them to reduce the cost of the loan. Mortgage-backed securities in action were a good example of this.

However, the problem with rehypothecation is that it does not clarify who is actually the boss.

last word

So, what exactly is hypothecation? In many cases, this means allowing the lender to use your assets as collateral for loans taken out. Unless you are a trader, you are unlikely to encounter this in other areas of your financial life.

Hypothecation lets you reduce the interest rate you pay, but it comes with a large penalty for non-payment. Those who do not comply with the Hypothecation Agreement can take back their property, including their car and house. Penalties for failing to repay unsecured loans are comparatively mild, such as low credit scores.

FAQ on Hypothecation

FAQ on Hypothecation Loan Meaning in Hindi

What is an example of hypothecation?

Mortgages are a good example of this. If they fail to make payments, banks offer homeowners a reduced borrowing cost in exchange for the right to take back their home.

What is the difference between Hypothecation and Mortgage?

A mortgage is a loan taken to buy a property. Hypothecation is the agreement that the lender can take back the home in case the homeowner fails to meet the terms of the repayment. Mortgages do not necessarily require an asset to be assumed, although the overwhelming majority do.

What is Hypothecation in Banking Example?

In banking, hypothecation occurs when the bank secures a loan by pledging collateral. Banks did this by selling mortgage-backed securities prior to the 2008 financial crisis. They pledged loan repayments from borrowers as collateral in return for increased lending capacity.

What is the difference between hypothecation and rehypothecation?

Hypothecation is where you use your assets as collateral to secure the loan. Rehypothecation is where you use other people’s assets as collateral. For example, banks and brokers may use their client’s assets as collateral for their own purposes.