What does it mean to Pledge Assets as Collateral?
To pledge assets as collateral (or Pledging) is the act of offering assets as collateral to secure loans. Assets pledged can be in the form of security holdings and act as assurance for recovering the borrowed amount should a borrower fail to pay up.
How Does Pledging Assets as Collateral Work?
Borrowers and Lenders – Pledgers and Pledgees, negotiate an agreement to pledge certain assets as collateral. It provides pledgees a sort of guarantee that their money can be recovered, while allowing pledgers to get better interest rates on loans or mortgages.
Different Types of Pledging
- Pledged-Asset Mortgage – Ideal for people in higher income brackets, it is recommended when the eventual return on investment on the pledged assets far exceeds the interest rate of the loan acquired. This also brings down the tax rates levied on the pledged securities providing pledgers benefits on both ends. It also allows people to become property owners without down payments. This is also called a secured loan and involves the transfer of securities/collateral to the lenders name until the loan is paid in full. It does not involve selling the securities, just transfer of deeds to a different name.
- Hypothecate Pledging – In this scenario, there’s no transfer of deeds to the lenders name in order to pledge assets as collateral for borrowing loans. The borrower retains the rights to the pledged assets like a house or a portfolio of securities with the understanding that the lender may take possession of the same should the borrower fail to pay the loan dues.
