The mortgage of movable property for securing the loan is called hypothecation.
In other words, in the case of hypothecation, a charge over movable properties like goods, raw materials, goods-in-process is created.
Hart defines hypothecation as “a charge against property for an amount where neither ownership nor possession is passed to the creditor.”
According to Hart, when goods are made available as security for a debt without transferring the possession of the property to the lender, the transaction is hypothecation.
The goods remain with the borrower, and under a hypothecation agreement, he or she undertakes to transfer the possession whenever required to do so.
Hypothecation facility is also called ‘open loan facility.’ Hypothecation is a convenient method of borrowing for some concerns.
A manufacturing concern cannot pledge its raw materials, which are required for production every day. By hypothecating them, the company can continue the production and also avail the credit facility.
Being only an equitable charge on the movable property without possession, a hypothecation facility is risky as clean advances.
So it is granted only to parties if undoubted means with the highest integrity.
As goods under hypothecation remain in possession of the borrower, extra care has to be exercised to see that the bank’s security is complete, adequate, safe, and available at times when required.
Differentiate between hypothecation and mortgage
Hypothecation means keeping movable assets e.g., machinery, goods, raw materials, etc. as security for taking a loan.
Mortgage means keeping immovable assets such as land, building, etc. as security for taking a loan.
Difference between hypothecation and pledge
In the case of hypothecation, the asset is not transferred to the lender. Instead, possession of the asset remains with the borrower. In case of a pledge, possession of the asset/goods remains with the lender.