These terms are used for creating a charge on the assets which is given by the borrower to the lender as a security for any loan. Thus, one of these terms will be normally used whenever an individual or a business firm avails any loan and the bank keeps some assets as a security, so that it will be able to sell the same in case that individual or the firm defaults in repayments.
(1) Pledge is used when the lender (pledgee) takes actual possession of assets (i.e. certificates, goods ). Such securities or goods are movable securities. In this case the pledgee retains the possession of the goods until the pledgor (i.e. borrower) repays the entire debt amount. In case there is default by the borrower, the pledgee has a right to sell the goods in his possession and adjust its proceeds towards the amount due (i.e. principal and interest amount). Some examples of pledge are Gold /Jewellery Loans, Advance against goods,/stock, Advances against National Saving Certificates etc.
(2) Hypothecation is used for creating charge against the security of movable assets, but here the possession of the security remains with the borrower itself. Thus, in case of default by the borrower, the lender (i.e. to whom the goods / security has been hypothecated) will have to first take possession of the security and then sell the same. The best example of this type of arrangement are Car Loans. In this case Car / Vehicle remains with the borrower but the same is hypothecated to the bank / financer. In case the borrower, defaults, banks take possession of the vehicle after giving notice and then sell the same and credit the proceeds to the loan account. Other examples of these hypothecation are loans against stock and debtors. [Sometimes, borrowers cheat the banker by partly selling goods hypothecated to bank and not keeping the desired amount of stock of goods. In such cases, if bank feels that borrower is trying to cheat, then it can convert hypothecation to pledge i.e. it takes over possession of the goods and keeps the same under lock and key of the bank].
(3) Mortgage : is used for creating charge against immovable property which includes land, buildings or anything that is attached to the earth or permanently fastened to anything attached to the earth (However, it does not include growing crops or grass as they can be easily detached from the earth). The best example when mortage is created is when someone takes a Housing Loan / Home Loan. In this case house is mortgaged in favour of the bank / financer but remains in possession of the borrower, which he uses for himself or even may give on rent.
Difference Between Pledge, Hypothecation and Mortgage at a Glance:
| Pledge | Hypothecation | Mortgage | |
| Type of Security | Movable | Movable | Immovable |
| Possession of the security | Remains with lender (pledgee) | Remains with Borrower | Usually Remains with Borrower |
| Examples of Loan where used | Gold Loan, Advance against NSCs, Adv against goods (also given under hypothecation) | Car / Vehilce Loans, Adv against stock and debtors | Housing Loans |
What is an Assignment ?
There is another term (i.e. Assignment) which is sometimes confused with above terms. An assignment constitutes an action taken with a contract. Assignment occurs when the owner of a contract, known as the assignor, gives a contract to another party, known as the assignee. The assignee assumes all responsibilities and benefits of the contract. When it comes to loans, assignment can relate to life insurance policies and mortgage contract from one party to another. Mortgages and other contracts sometimes contain provisions limiting or stipulating conditions for assignment.
One example of assignment is 'transfer by the holder of a life insurance policy (the assignor) of the benefits or proceeds of the policy to a lender (the assignee), as a collateral for a loan'. In such case in the event of the death of the assignor, the assignee is paid first and the balance (if any) is paid to the policy's beneficiary. However, insurance policies other than life insurance, may not be used for this purpose.
