Legal Definitions - hypothecate

To hypothecate an asset means to pledge it as security for a debt or loan, while the person who owns the asset retains possession and use of it. Essentially, you are offering something valuable as a guarantee that you will repay a debt, but you don't actually hand over the item itself to the lender. If the debt is not repaid as agreed, the lender then has the legal right to take possession of and sell the hypothecated asset to recover their money.

Here are some examples to illustrate this concept:

• Real Estate Mortgage: When an individual purchases a home and takes out a mortgage from a bank, they hypothecate the house itself. The homeowner lives in and uses the property, retaining physical possession. However, the bank holds a lien on the property, meaning if the homeowner fails to make their mortgage payments, the bank has the legal right to foreclose on the house and sell it to recover the outstanding loan amount. The house serves as collateral without being physically transferred to the bank.

• Securities-Backed Loan: An investor might want to borrow money for a personal expense without selling their valuable stock portfolio. They can obtain a loan by hypothecating their investment securities (like stocks or bonds) to a brokerage firm or bank. The investor continues to own the securities, they appear in their account, and they can even trade them (within certain limits). However, the brokerage or bank has a claim on these assets. If the investor defaults on the loan, the lender can seize and sell the pledged securities to recoup their funds.

• Business Inventory Financing: A manufacturing company might need a line of credit to manage its day-to-day operations and purchase raw materials. To secure this loan, the company could hypothecate its existing inventory of finished goods or raw materials. The company retains physical possession of the inventory, continues to use raw materials in production, and sells finished goods to customers. However, the bank holds a security interest in that inventory, allowing them to claim and sell it if the company fails to repay the line of credit as agreed.