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What is Hypothecation?

Malcolm Tatum
By
Updated: Feb 21, 2024

Hypothecation is the action of pledging specific assets as collateral to obtain a loan. These securities may be in the form of real estate, different types of securities, or any other property that the lender deems acceptable as collateral. Along with securing loans for the purchase of property, such as with a mortgage, the hypothecation may also involve using the debit balance in a margin account to secure what is known as a margin loan.

With hypothecation, the borrower is allowed to retain possession of the asset or property that is pledged as collateral. In most cases, the borrower also remains the owner of record for the asset. The lender receives a lien that can be used to gain access to the asset in the event that the borrower defaults on the loan for any reason. This helps to reduce the degree of risk that the lender assumes in exchange for extending the loan.

For the borrower, hypothecation can often help make the process of financing a purchase much easier. Since the loan is secured by the pledging of some asset that the lender deems acceptable, the possibility of obtaining a more competitive rate of interest on the loan is increased. The lower interest rate will save the borrower money over the life of the loan, without having an impact at the outcome. Assuming that the borrower makes all loan payments on time, he or she eventually retires the loan and the lien on the pledged property is discontinued.

The process of hypothecation is extremely common in many loan situations. Mortgages are a prime example, with the property that is purchased by the borrower used as collateral for the mortgage loan. Businesses also engage in hypothecation when obtaining financing for the purchase of manufacturing equipment, vehicles, or other assets that are necessary to the ongoing operation of the company. Consumers sometimes use this arrangement in order to purchase various goods for the home, such as large appliances.

Investors may sometimes use the balance in a margin account as collateral, making use of the asset to secure the means to settle other debts or to finance some type of investment opportunity. As with other assets used in a hypothecation, as long as the margin loan is repaid according to terms, the balance in the account remains intact and eventually is released from any type of lien imposed by the lender. Should the borrower fail to pay off the loan in a timely manner, the lender can take full control of the balance in the margin account, and use those funds as he or she sees fit.

WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Malcolm Tatum
By Malcolm Tatum
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing to become a full-time freelance writer. He has contributed articles to a variety of print and online publications, including WiseGeek, and his work has also been featured in poetry collections, devotional anthologies, and newspapers. When not writing, Malcolm enjoys collecting vinyl records, following minor league baseball, and cycling.
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Malcolm Tatum
Malcolm Tatum
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing...
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