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Anyone who has taken out an auto loan or mortgage has likely entered into a hypothecation agreement to secure the loan. Hypothecation is common with secured loans.
In the case of getting a mortgage on a home, without hypothecation, a borrower could default on the mortgage and yet still be able to keep the house. No financial institution would be willing to lend with such risk, leaving most people unable to buy a home without the cash to do so. Hypothecation makes lending and borrowing possible.
For borrowers who are unsure precisely what hypothecation is, here is a look at what this term means and why it benefits both borrowers and lenders.
What Is Hypothecation?
Hypothecation is the pledging of an asset as collateral for purposes of securing a loan. The borrower does not pass asset ownership rights to the lender, but if the borrower does not make their loan payments as outlined in the loan terms, the lender can take possession of the asset to recover their loss.
For a home or auto loan, this can mean foreclosure or repossession for the borrower. With most mortgages and auto loans, hypothecation is a standard requirement.
Hypothecation is only used with secured loans, such as secured personal loans and mortgages. Often with these types of loans, the asset being pledged as collateral has nothing to do with the reason for the loan other than to secure it. For instance, a borrower may pledge jewelry, a vehicle, or even stocks or bonds as collateral for a secured personal loan.
Hypothecation is also used in investing when investors buy on margin or short stocks. Short selling involves borrowing securities and requires the investor to open a margin account to pledge as collateral. Buying on margin involves borrowing money from a broker or bank to buy securities. The investor typically pledges securities or other investments as collateral.
How Does Hypothecation Work?
Here is a closer look at how hypothecation works for securing a mortgage or auto loan and investing.
Hypothecation for Mortgages and Auto Loans
When borrowers enter into a loan contract, they agree to pay back the loan as outlined in the loan contract. However, a bank or lender will not risk lending thousands of dollars without one of two things: collateral valued high enough to cover the loan or an extremely high interest rate. Lenders need a way to recoup their loss if a borrower defaults.
The borrower hypothecates the house or vehicle in exchange for a lower rate loan. If the borrower continues to make on-time payments, they can live in the home or drive the car …….
Source: https://www.gobankingrates.com/banking/interest-rates/hypothecation/
