Hypothecation

Definition of "Hypothecation"

Written by

Caroline Kovacs

A.Z. & Associates

The definition of Hypothecation in real estate is the use of one’s belongings as collateral for a loan. This practice assures the lender that, whether the borrower is able to pay or not, the lender will not sustain a net loss. Hypothecation can also be used to describe a situation in which a third party pledges their belongings or financial means as collateral for a loan. 

In order to explain exactly what is hypothecation in real estate, you have to understand that it can be done through a property. By hypothecating that property, you offer it as safety collateral for a loan or mortgage. The property remains in the ownership of the borrower but the ownership rights can be taken away by the lender, most often the bank, if the borrower can’t respect the terms of the loan.

Examples of hypothecation in real estate 

Hypothecation in real estate is applied when a building is guaranteed as a deposit or collateral for a mortgage or a loan from a bank. In this situation, the bank does not have rights for the property or for any income that the property generates, but it can seize the property if the owner does not respect terms of the mortgage and its payments.

Ellen is a 28-year-old art student. After graduating with her BA at 22, getting a respectable job as a graphic designer and carefully saving her money, Ellen soon had enough money to buy her own car and move into a shared apartment. 

After a few years of saving up, Ellen finally had enough money to afford the down payment for a cozy little bungalow in the suburbs. However, due to her lack of a well established credit history, Ellen was asked to use some of her assets as collateral in order to assure her commitment. Confident in her financial stability, Ellen pledged her car, her Macintosh laptop, and her studio equipment as collateral for the loan. In real estate, this would be referred to as hypothecation. 

Another great example of hypothecation would be that of Gary and his good friend Jill. As a well established real estate investor, Gary is presented with an opportunity to buy a shopping mall in a rapidly industrializing part of town. However, Gary’s holdings are not quite significant enough to constitute collateral for the loan needed to purchase the shopping mall. 

Fortunately for Gary, Jill comes to the rescue. Confident in Gary’s ability to turn a profit renting out spaces in the shopping center, Jill pledges one of her holdings, a large undeveloped plot of land, as collateral for Gary’s loan. The bank accepts the offer and grants Gary the funds needed to purchase the space. 

What can hypothecation do for you

Hypothecation in real estate can make it easier to get a loan or a mortgage from the bank because the property is a valuable asset and it ensures the bank that you have options to cover the loan or mortgage as well as the motivation to pay the installments.

Looking at the hypothecation meaning we have to underline that the title, possession or ownership of the estate is not shifted, but it can be through a foreclosure crisis if the borrower can not respect the terms of the mortgage or loan.

Hypothecation grants the security of a loan. The opposite would be unsecured loans which are more difficult to get as they provide no collateral. Hypothecation real estate makes it easier to get loans as the estate itself becomes collateral in case payments are not met.