What is hypothecation?
Hypothecation, also known as collateral assignment, occurs when something is pledged as collateral to secure a loan or debt, without the necessity of giving up possession.
Hypothecation is historically applied to using personal property as security, rather than real property as occurs with a mortgage. Stated another way, a mortgage is a contract where specific real estate is hypothecated, without the necessity of giving up possession of the property.
Trust deeds and notes
A loan collaterally secured by an existing trust deed note is only indirectly secured by real estate. When the collateralized loan is in default – delinquent – the lender repossesses the trust deed note pledged to secure repayment, not the real estate described in the trust deed.
On repossession of the pledged trust deed note due to a default in the collateralized loan it secures, a noticed sale takes place. The lender becomes the holder and owner of the trust deed note repossessed if they are the highest bidder to satisfy the collateralized loan.
For an example, consider a carryback seller who holds a note and trust deed received on their installment sale of a property. The carryback seller wants to retain ownership of the note, as opposed to selling it to obtain funds. Thus, to borrow money, the holder of a trust deed note (the carryback seller as borrower) conditionally assigns the note and trust deed to a lender as collateral pledged to secure the loan, i.e., hypothecation.
Here, the sole security for the loan is the existing trust deed note – not the real estate described in the trust deed. To document the collateralized loan transaction, the borrower signs and delivers to the lender a collateral note and security agreement as evidence of the debt owed and trust deed pledge arrangements. [See RPI Form 438]
Further, the borrower signs a security device which is recorded in the county where the real estate is located. The recording gives the public notice of the security link between the collateralized loan and the existing trust deed note, called a collateral assignment. [See RPI Form 446]
On a default in the collateralized loan, the lender repossesses the trust deed note which is security for the loan. Here, the lender does not foreclose on the underlying real estate which is security for the repossessed trust deed note – unless a default in the trust deed occurs.
Related Terms
Collateral assignment is an agreement providing additional, cumulative and concurrent security for a debt, in the form of personal property, to additionally secure the property owner’s performance under the debt.
Pledge is the offering of an asset (such as an existing carryback note) as collateral or security for another, unrelated debt.
History behind the word
The word hypothecate stems from both Medieval Latin and Greek. In Medieval Latin, hypothecat, the past participle stem of hypothecare or hypotheca, meant “a pledge.” In Greek, hypotheke means “a deposit, pledge, mortgage.”
The current use of the word stems from the 1680s based on the definition to “pledge (something) without giving up control of it.”
