Although both Pledge and Hypothecation are the modes of creating a charge over movable assets/properties of the borrowers to back up the loans/debts. However, there is some key difference between pledge and hypothecation.
The banks or financial institutions/companies pledge the goods of a borrower as collateral against the loans sanctioned to the debtor.
The pledge and hypothecation, both are applied on movable assets of the debtor by the financial institutions to secure the debt. If the borrower is unable to repay, the debt the banks or financial companies possess the rights to sell the property to recover the loan.
Now let us discuss the key differences between pledge and hypothecation.
Pledge vs Hypothecation (Comparison Table):
|Basis of Comparison||Pledge||Hypothecation|
|Meaning||Pledge is utilised when there is actual possession of assets as collateral.||Hypothecation is used when there does not exist any actual possession of property.|
|Defined Under||Section 172 of Indian Contract Act, 1872||Section 2 of SARFAESI ACT, 2002|
|Possession of Property||Lender/creditor||Borrower/debtor|
|Rights of Lender||Can sellout the property if borrower defaults.||Will have to seize property first then sellout.|
|Legal Documents||Deed of Pledge||Hypothecation Agreement|
|Parties||Pawnee and Pawnor||Hypothecator and Hypothecatee|
|Examples||Gold Loan||Car Loan|
Difference Between Pledge and Hypothecation:
The major difference between pledge and hypothecation from borrower point of view is that the borrower has to handover the property to the lender (banks) in case of the pledge to get a loan, on the other hand, the debtor doesn’t need to transfer the property to the lender. That means the borrowers can utilize their property as usual during the loan period.
The pledge and hypothecation can also be distinguished based on the following perspective.
1) Meaning & Definition:
The pledge refers to the bailment of goods/properties to the lender as security against the loan sanctioned for the fulfilment of the financial obligation of the borrower.
In other words, a pledge is utilized when there exists an actual possession of security/assets as collateral by the banks/lender to avail the loans.
For more detailed explanation about pledge follow the links below.
On the other hand, Hypothecation is the practice through which the banks or finance company (creditors) create a charge on property of the debtor without actual possession.
In other words, Hypothecation is used whenever loans are granted against movable security as collateral without actual possession of the property. That means the property which is hypothecated retains with the borrower.
For more details.
2) Defined Under:
Pledge is defined under Section 172 of the Indian Contract Act, 1872 whereas Hypothecation is defined in Section 2 of SARFAESI Act, 2002 (Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act).
3) Possession of Property:
In case of Pledge, the property of debtor/borrower is under the custody of Lender (banks or finance company), on the other hand, in case of hypothecation, the possession of property retains with the borrower.
4) Rights of Lender:
If the borrower defaults, in case of hypothecation, the lender first has to seize the property then could go for auction whereas, in case of pledge, the lender can sellout the property to recover the debt.
5) Legal Documents:
In case of pledge, the legal document is called Deed of Pledge whereas a Hypothecation Agreement is used when it comes to hypothecation.
The parties involved in a Pledge are known as Pawnee and Pawnor whereas in case of hypothecation the parties are known as Hypothecator and Hypothecatee.
7) Loan Examples:
Gold Loan, Loan against Fixed Deposits are the best and popular real-life examples of loans/debt these days which are pledged.
Vehicle Loans (Auto & Bike Loan), Loan against Inventory, machinery, Raw materials (CC loan) are examples of Hypothecation.
Hope the difference between Pledge and hypothecation would have been cleared to you. These differences can be easily understandable with real examples.
Hence, the Gold Loans are the most suitable example of Pledge whereas Car Loans could be the best example of Hypothecation.
To obtain a Gold Loan, you will have to keep the gold (of equal or more value) with the banks and if you default, the bank will sell your gold to recover its debt.
On the other hand, in case of Car Loan, your car is hypothecated till the repayment of the loan in case you default, the bank will seize your car and sellout to recover the loan amount.