Businesses often need money to raise their capital and come up with greater versions. Also individuals need money for their needs. Individuals and businesses both take credit from financial institutions to meet their need, and return the same after a stipulated period of time along with interest as charged when taking credit or loan.
In order to take loans, they need to keep some of their assets as securities with the financial institutions. The institutions give credit only if they are satisfied with the fact that they will get their money back. The assets kept as security should be of same or higher value than the credit amount taken.
Individuals and business take loans for various purposes like Personal loan, Home loan, Vehicle loan, Education loan, etc. There are various types of securities against which a loan can be taken. They have been divided into four types which are:
A pledge is a contract between the individual or group of individuals who borrow the money and lender in which the borrower offers an asset as a security to the lender.
- This means the actual possession of the assets against which loan is taken remains with the lender until the loan is paid back.
- In case that the borrower is not able to meet the obligation i.e. return the money borrowed with specified time, the lender has full rights to sell the assets and recover his losses along with interest.
- A pledge contract includes securities like goods, certificates, gold, etc.
- Pledge contract is on movable item.
Lien is similar to pledge in a way that it is also used for the security purpose. But a lien is formed by agreement between the two parties unlike pledge.
- Agreement implies that a lien is imposed by law, which is not in the case of contract.
- So lien is a legal claim on the securities.
- Like pledge, the lender has the rights to have the possession of the securities against which the loan is given, but the lender cannot sell the securities to recover his losses unless stated in the agreement.
- Unlike pledges, Lien agreement can be on property too.
It refers to the financial arrangement in which the borrower takes loan against any movable assets or for movable assets and the possession of the asset also remains with the debtor (borrower).
- So the credit (borrowed money) and also the asset against which or for which a loan is taken, both remains with the borrower.
- However, in case of default i.e. not paying the amount of loan in specified time period, the institution which granted loan can take the possession of the asset and sell it to recover the amount.
- Hypothecation is on movable assets.
- Example includes taking a loan on vehicle or against vehicle, in which the vehicle remains with you during the loan term period.
Like hypothecation, in Mortgage also the debtor or the borrower has the possession of goods but it is the loan against or for immovable objects.
- The immovable objects include land, buildings or anything that is attached to the earth.
- Like hypothecation, in mortgage also the possession can be taken by the lender in case of default and the lender can sell the immovable object to recover his amount.
- Example includes taking Home loan, in which the property remains with the borrower during the loan term period.
Assignment is another type of charge on current assets or fixed assets. Under assignment, the charge is created on the assets held in the books. It is another mode of providing security against borrowing.
Eg. of assignment are insurance policies, book of debts, receivables, etc. financed by the bank. A bank can finance against the book debts.