The difference between pledge, hypothecation, lien, mortgage and assignment lies in the security charge that can be created on any asset held by a lender against the money lend (usually called the collateral). The type of charge on assets defines whether the agreement can be classified as pledge or lien or mortgage.
There are several types of security interests which can be adopted by banks or lenders depending upon the collateral involved and the circumstances. Different forms of creating charge on assets can be described below:
Pledge is commonly used for goods or securities such as gold, stocks, certificates etc. The lender (pledgee) holds the actual possession of such securities till the time the borrower (pledger) has the borrowed amount with him. Once the borrowed amount has been returned, the securities are returned as well. If the pledger defaults on the loan amount, the pledgee can sell off the goods pledged with him as security in order to recover the principal and the interest amount. In this case risk of lending comparatively reduces because possession of asset is with lender.
Hypothecation is usually when the charge is on movable assets rather than having charge on fixed assets. However, hypothecation is different from pledge in the sense that the possession of such movable security stays with the borrower. Hence, in an event of default, the lender is first required to take the possession / seize of such property or asset in order to recover the principal and interest. Example of hypothecation is vehicle financing where the lender has the asset that has been hypothecated against the loan with a bank. If the borrower defaults, the bank then takes the possession of the vehicle, after sufficient notice, in order to recover the money.
Under a lien, the lender gets the right to hold up a property or machinery used as collateral against funds borrowed. However, unless the contract states otherwise, the lender doesn’t have the right to sell of the property or the asset, if the borrower defaults on the loan. Examples of lien include rent receivable, unpaid fees etc. It is a right given to the creditor to retain/possess the security until the loan amount is discharged. Since possession is with the creditor, it is the strongest form of security. Lien can be on both movable and immovable property. But generally, lending companies choose to have mortgage on immovable property and lien on movable security like shares, gold, deposits etc.
Under a mortgage, the legal ownership of the asset can be transferred to the lender if the borrower defaults on the loan amount. However, the borrower continues to remain in the possession of the property. Mortgage is usually used for immovable assets (example: house, land, building or any property which is permanently fixed to the earth or attached to the land). Home loans classify as mortgage.
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. Examples of assignment include life insurance policies, book of debts, receivables, etc. which can be financed by the bank. For example – A bank can finance against the book debts. In such a case, the borrower assigns the book debts to the bank.1–3