5 Important of Borrowing Terminologies You Should Know

What is the Difference between these popular terms- Pledge vs. Hypothecation vs. Lien vs. Mortgage vs. Assignment?

In simpler terms, loans are of two types secured and unsecured loans. Lenders look for some sort of safety cushion or collateral before lending money. As lending money involves risk, lenders charge interest against it.

As a rule of thumb; the higher the lending risks higher the cost of lending. Borrowers look to reduce the risk and lower the borrowing cost by offering collateral to the lenders. The terms and conditions between the two parties can take several legal forms or agreements.

The characteristics of each loan agreement define the difference between the different terms such as a straight mortgage or Mortgage Assignment.

Let’s start with the most commonly used term first.

1) Mortgage:

It is the most commonly used form of loan for buying houses and property. It is defined as a loan against collateral for predetermined loan term and repayment conditions. The underlying property works as collateral.

The key point with a mortgage is the lenders allow the asset or property usage and temporary possession before repayment of the loan. Mortgage borrowers make the principal and interest payments over time until the full repayment to claim the legal ownership in full and clear terms.

Mortgage contract by loan interest rate, tenure, and lender defines the mortgage type. In case of default, the borrowers have the right to take possession and sell the collateral to recover the repayment balance.

2) Hypothecation:

As a borrower when you own an asset such as a house, you can pledge it as collateral to secure a loan from lenders or banks. You’ll keep the legal ownership of the asset or property and any income and losses occurring on it. For example, you may own an apartment placed on rental income that you can pledge as collateral to secure a loan without sacrificing the income.

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You pledged the house with a mortgage too, right? Yes, the key difference is the equity built with the asset. In a mortgage, you start with zero house equity, as you make payments the house equity builds over time. In a Hypothecation, you already have property or asset equity that you put as collateral.

3) Pledge:

By definition, a pledge is simply a promise of repayment against the loan. Practically, it is one step forward to mortgage or even a hypothecation contract.

You can temporarily own a house with a mortgage, start building equity until you reach the full repayment and legally own the house in full. You may keep that house under possession and secure a loan against it by putting it as collateral.

Lenders may not be willing to offer you a loan without the possession of the collateral; you have to “pledge” or handover the asset to the lenders. Borrowers remain the rightful owner of the pledged asset, but the possession remains with the lender. It makes the loan agreements more secure and reduces the costs i.e. interest charged.

4) Assignment:

Assignment refers to the transferring of rights attached with a contract to another party. With transferring the rights, both benefits and risks are transferred to the other party.

However, the legal requirements impose a clear indication of the purpose and rights being transferred. It may take several forms in business and loan terms. In the real estate sector, mortgage or property assignments are common examples of such contracts.

Carrying forward our example, you may consider moving to another city before your house mortgage completes the term. Either you can keep making payments after relocation (additionally the new mortgage too) or transfer the rights to another party.

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When you assign the mortgage terms to the other party with rights transferring, it is called an Assignment. In case of default, the lenders to the mortgage contract will still keep the right to seize the property.

Once you assign the rights to another party, you no longer have the rights over the asset or property.

5) Lien:

Lastly, the Lien is the right that serves the lenders in the loan agreement. Lenders can exercise the right to seize the collateral if the repayment under agreed terms is not completed in full or partial. It transfers the possession of the collateral to the lenders giving them the right to sell and recover the balance of repayment.

 The borrowers may pledge one asset as collateral for more than one loan. The lien priority is decided on the types of loans and dues. By nature, a lien can take several forms such a court lien, property lien, bank lien, and so on.

In some cases, a court lien may take the form of blanket lien, meaning seizure of all assets of the borrowers to recover the loan repayments and taxes.

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