Everything You Need to Know About Hypothecation

Aalto Insights Team
Mar 2, 2023

For the first-time homebuyer, the task of navigating a real estate transaction can feel daunting. There’s no question that you’ll hear and see some real estate terminology that you’ve never heard before when purchasing a home. One term that you might encounter while obtaining a mortgage loan is hypothecation. If you’re unfamiliar with this concept or simply want to learn more about it, then this guide is for you. Read on for everything you need to know about hypothecation as a buyer.

Understanding Hypothecation

To understand hypothecation and the role it plays in real estate, let’s first define what this term means. 

Hypothecation Defined

Simply put, hypothecation refers to the process of agreeing to use an asset as collateral in exchange for money from a mortgage lender. Hypothecation only plays a role in secure loans, which can include auto loans, personal loans, real estate investing, or, most commonly, mortgage loans. Buyers who are looking to purchase residential or commercial real estate might opt for a secure loan, which requires the borrower to use collateral to qualify for the loan. Hypothecation is also a common practice when people are looking to buy an investment property, rental property, or even primary residence. 

Hypothecation means that the creditor can take possession of the asset if the terms of the agreement are not met. Like a typical secured loan, hypothecation guarantees that the creditor will not end up short-changed if the borrower is unable to pay back the loan or promissory note.

An Example of Hypothecation

Hypothecation can be a difficult concept to fully grasp, so here’s an example:

Let’s say you are interested in buying a house for $800,000 and need to get a mortgage loan from the bank to do so. There is a term added to the loan where you pledge the home as collateral for the loan — that's hypothecation. Although you technically own the home, you still have loan payments, which means that the bank can take possession of your home if you default on your payments. 

It’s worth noting that the borrower doesn’t give up the title, possession, or ownership rights to the house, or any income that it might generate. However, until the mortgage is completely paid off, the lender still retains the right to seize collateral should you fall behind on your payments.

Why Hypothecation Matters

When considering how to pay for your home, the overwhelming majority of buyers use a lender to obtain a mortgage loan during the homebuying process instead of paying in cash. Home mortgage loans often involve hypothecation for real estate transactions, including both residential real estate or a commercial property real estate.

When obtaining a secured loan, hypothecation matters because it provides a breakdown of what will happen if the borrower fails to meet the terms of the loan and the legal recourse that a creditor can take. If the borrower defaults on their payment, then the creditor has the legal right to take ownership of the home to recoup their money.

What Is Included in Hypothecation Agreement? 

A hypothecation agreement provides a detailed overview into the terms and conditions of the mortgage agreement. It also clearly outlines the legal recourse available to the creditor if the borrower defaults on their mortgage payments.

 This agreement normally includes: 

  • Title and ownership: Clearly states who holds the title to the hypothecated assets
  • Interest and default interest rate: The required interest rate the borrower must pay until repayment is complete
  • Insurance: Shows that the home is in good condition
  • Obligations: The rights, conditions, and terms that each party is obligated to adhere to
  • Insolvency: Details how the lender will recover unpaid loan if the borrower is unable to make payments
  • Security: What type of security is provided as collateral

Other Common Questions About Hypothecation

Hypothecation: entrepreneur writing on a notebook while looking at a tablet

Now that you understand what hypothecation is and the role that it plays in a mortgage agreement, here are some common questions. 

What’s the Difference Between a Secured Loan and an Unsecured Loan? 

Personal loans can be secured or unsecured. Also known as signature loans, unsecured loans refer to loans that do not require collateral. When loans are not backed by collateral, lenders take on more risk and often charge higher interest rates and require excellent credit scores from borrowers. 

A secured loan, on the other hand, is a loan that is backed by collateral, referring to a valuable asset you own, such as a home or car. Secured loans will often have lower interest rates and higher borrowing limits.

Hypothecation only happens in secured loans — unsecured loans don’t work with hypothecation, because there’s no collateral required.

What’s the Difference Between Mortgages and Hypothecation Agreements?

Although similar in nature, a hypothecation agreement and mortgage agreement are not the same thing. In a mortgage agreement, the title of the house goes from the owner to the lender to be used as collateral for a mortgage loan. In a hypothecation agreement, however, the title and possession of the house stay with the borrower unless the borrower defaults on their mortgage loan.

How Does Hypothecation Affect Possession?

In the event of default, the lender has the opportunity to recoup some of its losses if they are able to list the home as a foreclosure and then resell the home to a new buyer. That’s why it is important to carefully consider your repayment abilities when buying a new home, whether it’s a primary residence or rental property. Should you find yourself in a situation where you cannot make loan payments, be sure to contact your lender to discuss your options.

What Is Rehypothecation? 

Okay, stay with us — rehypothecation is what happens when a lender uses your collateral as collateral of its own to finance additional real estate loans. If you’re a buyer who is obtaining a secured loan using hypothecation, then it’s vital to prioritize payments on any loans that involve hypothecation. This can be a safeguard in preventing repossession of your property.

Start Your Homebuying Journey With Aalto Today

Hypothecation: FOR SALE signage

Now that you understand the role that hypothecation agreements play in commercial real estate transactions, you’re one step closer to knowing the ins and outs on how to buy a house

At Aalto, we are committed to assisting homebuyers through every step of the process. Our platform enables house hunters to easily search for properties for sale in the Bay Area.

Aalto is there to support you so that you can find a home you want on your terms and timeline, without the need to work with a traditional real estate agent. Instead, our innovative platform connects homebuyers and homesellers directly. Buyers can search homes for sale and embark on virtual tours, all from the comfort of their home.

When you work with Aalto, you will have access to our on-demand team. Whether you have questions about loan agreements or types of loans or interest rates, our team of experts has the knowledge you need. By choosing to buy with Aalto, buyers can receive up to 1.5% cash back on a home purchase. We refund up to 60% of the commission back to you, saving you money on your largest purchase. If you’re ready to start the exciting journey to finding your next home, then start browsing on Aalto today.

Aalto is a real estate broker licensed by the State of California, License #02062727 and abides by Equal Housing Opportunity laws. This article has been prepared solely for information purposes only. The information herein is based on information generally available to the public and/or from sources believed to be reliable. No representation or warranty can be given with respect to the accuracy of the information. Aalto disclaims any and all liability relating to this article.

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