Pledge - 15 Mints Seminar Notes

 

 Pledge - 15 Mints Seminar Notes

The Pledge (in Banking) refers to the mode of creating a charge over movable to avail the secured debt from any banks or financial institutions/companies.

      In other words, Pledge is the process of creating a charge over movable assets/ property of borrower against the availed loan by the banks or financial institutions/ companies/ lenders.

In case of a pledge, the property/goods/assets on which the charge has to be created is kept with the lender itself. Moreover, if borrowers default during repayment of loans, the lender/ banks have rights to sell the property by sending a prior notice to the borrower for recovery of advance/loan.

As per Section 172 of the Indian Contract Act, 1872 Pledge is defined as follows:

“The bailment of goods as security for payment of debt or performance of a promise is called Pledge. The bailor is called Pawnor whereas bailee is called Pawnee.”

Important points: 

• Pledge is defined in section 172 of the Indian Contract Act.
  
• The lender/ bank is known as pledgee whereas the borrower is called pledger.
• The possession of pledged goods/ assets is with the lenders/banks itself whereas ownership of goods/property remains with the borrower.
• If the borrower defaults or unable to repay the debt/ loan, the lender has rights to sell the pledged goods without the intervention of court for the recovery of debt by issuing a prior notice to the borrower.
• The banks/lender has to take care of pledged goods as the goods will have been returned (original condition) to the borrower after repayment of debt.
• Even if the bank/lender as a pledgee has a priority in custody over pledged goods but the lender doesn’t have rights to sell the goods in any circumstances until the borrowers deny/ unable to repay the loan.
• In a nutshell, we can conclude the concept of a pledge in banking from the above example as follows.
  

Conclusion:

• A Pledge is a process of creating a charge on movable assets to avail the secured loan.
• Mr A would be pledger whereas HDFC Banks will be pledgee.Gold being a movable property and gold loan as a secured debt has to be pledged with the bank.
• As gold is pledged, hence it is kept with the bank itself till the repayment of debt.
• To avail the personal loan no collateral is required as personal loan is an unsecured loan.
  

Hypothecation :

Hypothecation refers to the practices of creating a charge on movableassets/properties of the borrower, however, the possession of property retains with borrower itself.”

In other words, Hypothecation is the process through which the banks/lender pledge the properties of the borrower to secure the loans. Here the possession and ownership of property/ assets remain with the borrower but if the borrower defaults the ownership of goods is transferred to the lender/banks.

Moreover, if the borrower defaults or unable to repay the debt, the lender has the rights to seize and sellout (auction) the property to compensate or recover the debt/loan.

     The concept of hypothecation is defined in Section 2 of SARFAESI ACT 2002.

• Hypothecation is also created on movable properties only like pledge.
  
• Neither ownership nor possession of the movable properties/goods is transferred to the banks or financial institutions.
  
• In the case of hypothecation, the charge created is the equitable charge.
  
• When any business firms/owner hypothecate its stocks/inventory to obtain a loan/debt (CC loan), then such hypothecation is a floating charge.
  
• If the borrower defaults the loan, the lender will first seize and take possession of assets then he can go for auction to recover the debt.
  
• The borrowers don’t have the rights to sell the hypothecated assets until the debt obligation is fulfilled.
  

Example :

Vehicle loans (Auto/bike Loans) are the best example to understand the hypothecation. If an individual wish to purchase a car and doesn’t have sufficient funds to buy hard cash. He will surely approach the bank to get the vehicle loan. The bank will hypothecate the vehicle which is to be purchased and approve the loan.

That means the bank will create a charge (hypothecation) over the car till the repayment of the loan. In this case, both possession, as well as the ownership, retain with the borrower. The borrower enjoys the benefits of property and gradually repay the loan to the bank or finance company.

Mortgage : 

    The term mortgage refers to a loan used to purchase or maintain a home, land, or other types of real estate. The borrower agrees to pay the lender over time, typically in a series of regular payments that are divided into principal and interest. The property serves as collateral to secure the loan. A borrower must apply for a mortgage through their preferred lender and ensure they meet several requirements, including minimum credit scores and down payments. Mortgage applications go through a rigorous underwriting process before they reach the closing phase. Mortgage types vary based on the needs of the borrower, such as conventional and fixed-rate loans.

Important points :

• Mortgages are loans that are used to buy homes and other types of real estate.
  
• The property itself serves as collateral for the loan
  
• Mortgages are available in a variety of types, including fixed-rate and adjustable-rate.
• The cost of a mortgage will depend on the type of loan, the term (such as 30 years), and the interest rate the lender charges.
• Mortgage rates can vary widely depending on the type of product and the qualifications of the applicant.
  

How Mortgages Work:

Individuals and businesses use mortgages to buy real estate without paying the entire purchase price upfront. The borrower repays the loan plus interest over a specified number of years until they own the property free and clear. Mortgages are also known as liens against property or claims on property. If the borrower stops paying the mortgage, the lender can foreclose on the property.

For example, a residential homebuyer pledges their house to their lender, which then has a claim on the property. This ensures the lender’s interest in the property should the buyer default on their financial obligation. In the case of a foreclosure, the lender may evict the residents, sell the property, and use the money from the sale to pay off the mortgage debt.

The Mortgage Process:

Would-be borrowers begin the process by applying to one or more mortgage lenders. The lender will ask for evidence that the borrower is capable of repaying the loan. This may include bank and investment statements, recent tax returns, and proof of current employment. The lender will generally run a credit check, as well.

If the application is approved, the lender will offer the borrower a loan of up to a certain amount and at a particular interest rate. Homebuyers can apply for a mortgage after they have chosen a property to buy or while they are still shopping for one, a process known as pre-approval. Being pre-approved for a mortgage can give buyers an edge in a tight housing market because sellers will know that they have the money to back up their offer.

Once a buyer and seller agree on the terms of their deal, they or their representatives will meet at what’s called a closing. This is the time the borrower makes their down payment to the lender. The seller will transfer ownership of the property to the buyer and receive the agreed-upon sum of money, and the buyer will sign any remaining mortgage documents.

Types of Mortgages:

Mortgages come in a variety of forms. The most common types are 30-year and 15-year fixed-rate mortgages. Some mortgage terms are as short as five years while others can run 40 years or longer. Stretching payments over more years may reduce the monthly payment, but it also increases the total amount of interest the borrower pays over the life of the loan.

The following are just a few examples of some of the most popular types of mortgage loans available to borrowers.

Fixed-Rate Mortgages:

With a fixed-rate mortgage, the interest rate stays the same for the entire term of the loan, as do the borrower’s monthly payments toward the mortgage. A fixed-rate mortgage is also called a traditional mortgage.

Adjustable-Rate Mortgage (ARM):

With an adjustable-rate mortgage (ARM), the interest rate is fixed for an initial term, after which it can change periodically based on prevailing interest rates. The initial interest rate is often a below-market rate, which can make the mortgage more affordable in the short term but possibly less affordable long-term if the rate rises substantially.

ARMs typically have limits, or caps, on how much the interest rate can rise each time it adjusts and in total over the life of the loan.

Interest-Only Loans:

Other, less common types of mortgages, such as interest-only mortgages and payment-option ARMs, can involve complex repayment schedules and are best used by sophisticated borrowers.
Many homeowners got into financial trouble with these types of mortgages during the housing bubble of the early 2000s.1

Reverse Mortgages:

As their name suggests, reverse mortgages are a very different financial product. They are designed for homeowners 62 or older who want to convert part of the equity in their homes into cash.

These homeowners can borrow against the value of their home and receive the money as a lump sum, fixed monthly payment, or line of credit. The entire loan balance becomes due when the borrower dies, moves away permanently, or sells the home.

Example :

Mortgage rates were at near-record lows in 2020. According to the Federal Home Loan Mortgage Corporation, average interest rates looked like this as of August 2021:

30-year fixed-rate mortgage: 2.87%
15-year fixed-rate mortgage: 2.15%
5/1 adjustable-rate mortgage: 2.44%3

A 5/1 adjustable-rate mortgage is an ARM that maintains a fixed interest rate for the first five years, then adjusts each year after that.

Lien :

A lien is a judgment or legal right in respect of properties that are usually used as collateral to pay a debt. A creditor or a legal opinion may create a lien. A lien helps to protect an underlying obligation, such as repaying a loan. When the underlying duty is not fulfilled, the lender will be entitled to seize the asset, which is the subject of the lien. Most forms of liens are used to protect properties.

Types of Lien

The two types of Lien which are recognized by the common law courts are:

• Particular lien
  
• General lien
  

In Particular lien, the person reserves the right to retain the possession of the goods until the charges due in respect of the property are paid.

A general lien is a right to retain the possession for the payment of the sum which is owed and even if the payment is not connected with the property in possession.

Section 170 of the Indian Contract Act, 1872 deals with a particular lien while Section 171 deals with General Lien.

Particular lien:

Bailee’s particular lien, which is specified under section 170, states that where the Bailee has in accordance with the purpose of Bailment, rendered any service which involves activity such as the exercise of Labor skill in respect of the goods which are bailed, he has in absence of the contract to the contrary, a right in order to retain such type of goods until he receives due remuneration for the services he has rendered in respect of them.

General Lien :

A general lien is defined under Section 171 of the Indian Contract Act, 1872. Section 171 talks about the General Lien of bankers, factors, wharfinger, attorneys and policy brokers, in absence of a contract to the contrary, retain, as a security for the general balance of the account, and any goods which are to be bailed to them unless there is an express contract to that effect.

Generally, the service providers are given the privilege of general lien. These identity service providers reserve a right to retain the goods which are bailed to them for the sake of a general balance of sum which is due to their customer. This particular Section is quite anxious to limit the use of general liens by telling that no person reserves a right to claim a general lien unless the parties have provided for it in their contract in express terms. Lien is considered as a ‘primitive remedy’ and common law does not encourage it but just took a note of it. A general lien could particularly impede trade and commerce because everybody can hold onto goods of one and another.

Presented By

Archana

Banking Student

Magme School Of Banking