What does pledge, mortgage and hypothecate mean with respect to business loans?

The kind of loans you’ve mentioned above are types of secured loans that are available on the market.

A secured loan is one wherein you avail of a loan after having presented the lender (bank or NBFC) with some form of a collateral. A collateral can be some form of property, or asset, or other moveable assets like vehicle or gold. The asset you present the lender is kept as collateral. This means that if you are unable to service or repay your loan, the lending company can take ownership of your collateral to recover the losses made.

There are different types of secured loans in the market such as:

- Mortgage

- Hypothecation

- Pledge

Mortgage

A mortgage is a secured debt instrument, wherein the borrower is obliged to keep collateral in return for a loan. Generally, immovable possession, such as a house or land, is kept as a collateral in mortgage against loans. The financiers have the title of ownership of the asset until the borrowed amount is repaid in full. Upon complete payment of the equated monthly instalments (EMIs), the ownership of the asset is transferred back to the borrower.

Hypothecation

Hypothecation is a slightly different form of secured loan than a mortgage. In hypothecation, the borrower provides collateral such as property, vehicles, stocks or shares but continues to retain total ownership.

Entrepreneurs and small-business owners may, therefore, avail of a loan without worrying about losing ownership of the asset. Since this practice provides security to the lender due to the collateral provided by the borrower, the financier offers a lower rate of interest as compared to an unsecured loan.

Hypothecation, therefore, helps the borrower to obtain a business loan on favourable terms. However, the borrower faces the risk of losing the asset if the EMIs of the loan are not paid on time.

Pledge

Borrowers can choose to keep immovable assets such as gold, advances against goods, advances from National Savings Certificate (NSC), and others as security against a loan. This practice is known as pledging, wherein the lender (also known as the pledgee) takes actual possession of the assets. In case the borrower defaults on payments, the lender has the right to sell the collateral and recover the unpaid amount.

All these kinds of secured loans differ from each other with respect to the nature of the asset. Borrowers may keep movable assets like gold, vehicles, or any other as collateral against the business loan in case of a pledge or hypothecation.

In contrast, only immovable property like land or building may be kept as security in case of a mortgage. It is important for entrepreneurs to choose the collateral to be kept against the loan, based on the type of asset that is owned by the business.