Hypothecation

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DEFINITION of 'Hypothecation'

The established practice of a borrower pledging an asset as collateral for a loan, while retaining ownership of the assets and enjoying the benefits therefrom. With hypothecation, the lender has the right to seize the asset if the borrower cannot service the loan as stipulated by the terms in the loan agreement. Hypothecation also refers to securities in a margin account that an investor uses as collateral to borrow funds from a brokerage.

BREAKING DOWN 'Hypothecation'

Since the practice of hypothecation provides security to the lender because of the collateral pledged by the borrower, the lender generally offers the loan at a lower rate of interest than on an unsecured loan.

Mortgages and margin loans are the most common examples of hypothecation. While it enables the borrower to obtain loans on more favorable terms than unsecured loans, the borrower risks losing the asset if prices plunge precipitously and the loan cannot be serviced. For example, a record number of U.S. homeowners lost their homes to foreclosure in the wake of the 2006-08 housing collapse and financial crisis, as home prices plunged and interest rates on mortgages rose.

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