You might be thinking what is hypothecation and how does it actually work? Whether it's a car loan, business loan, or trading in the stock market, hypothecation is a term worth knowing. Let’s understand it better in this blog.
Hypothecation Meaning: Understanding the Basics
Hypothecation means the borrower provides an asset for a loan while still having possession over it. A hypothecation is more beneficial than a mortgage since, in a mortgage, the lender gains rights over the asset immediately. In a hypothecation, the lender has a legal claim over the asset and can take action only if repayments are missed.As an example, if you take a car loan, the bank will be a hypothecate (the lender), and you will be a hypothecator while you keep driving the car. The bank will have rights to that property if you fail to pay back the car loan. That same thing would apply to business loans; the business can hypothecate its inventory, machinery, or accounts receivable but still do the business.
Why Is Hypothecation Used in Loans?
Using hypothecation lowers the risk in lending for the lenders. Since an asset is offered as security, the lender is assured that the loan can be adjusted against the asset in case of default by the borrower.In the case of borrowers, hypothecation enables them to get loans without losing complete ownership of their assets. This is important in areas such as vehicle financing, business expansion, and share trading, where there is a need for quick access to funds without losing control over important assets.
Some Common Examples of Hypothecation in Real LifeNow that we are through with understanding hypothecation meaning, let's look at some of the most common usages of hypothecation:
1. Car Loans
While taking a car loan, a lender's name would appear in the registration certificate of the car and the vehicle is hypothecated to the bank until the loan is fully repaid. The lender, after receiving all loan payments from the borrower, issues him the NOC (No Objection Certificate), and then the hypothecation can be removed from the vehicle's registration.
2. Business Loans
Hypothecation - in a business loan contract, the borrower usually uses hypothecation in pledging his stocks and machinery or future revenues by way of hypothecation to guarantee the funds he would access for business without having to sell any important asset.
3. Margin Trading in the Stock Market
Margin traders give brokers pledges of their securities under hypothecation. This enables them to use their current shares as collateral to borrow money to purchase further stocks.
Risks of Hypothecation
Hypothecation allows the borrower to keep ownership of the property being pledged; however, if the borrower is unable to repay the financing, serious consequences follow:Asset Repossession – In the case of loan default, the lender shall have the right to take possession of the asset and sell it so they may recover the outstanding amounts.
Legal Actions – Under extreme conditions, lenders can initiate legal proceedings against a borrower if they fail to pay the repayment amount.
Credit Score Damage – Your credit score suffers when you default on a loan while under hypothecation, which makes it more difficult to obtain loans in the future.
Removing Hypothecation from Assets
It is important to have the hypothecation tag removed from your asset once you repay the loan in full. Here is how you can carry this out:For Car Loan:
Request an NOC from the lender.
Once you receive the No-Objection Certificate (NOC) from the lender, you must present it in person at the Regional Transport Office (RTO) and have the lender's name removed from your vehicle's registration certificate.
You must also get your insurance policy updated to reflect your sole ownership of the car.
For Business Loans:
Obtain the loan closure letter given by the lender stating that hypothecation assets are free of all claims.
You should also inform stakeholders like suppliers and partners about the clearance.
After doing all these, you have regained full legal title to your asset.
