These terms are basically related while creating a charge on the assets, which are provided by the borrower to the lender as a security to loan. In both cases, the lender can sell an asset and loan amount if the situation so arises.
Pledge and Hypothecation are widely used while borrowing funds from financial institutions. Let us understand the similarities and differences between Pledge and Hypothecation.
Pledge is a contract between the lender (pledgee) and borrower (pledgor), where the borrower offers an asset (pledges an asset) as a security to the lender. Here the pledgee takes actual possession of assets such as securities or goods. The pledgee will hold the possession untill the entire amount is repaid.
In case of default by the borrower, the pledgee has a right to sell the goods in his possession and recover the money towards the due amount. If there is surplus remaining after the asset is sold, the amount is returned back to the pledger (borrower).
Some examples of pledge are gold /jewellery loans, advance against goods or stock, advances against National Saving Certificates etc.
Hypothecation is a contract between the lender and borrower, where the borrower agrees to take possession of an asset in case of default. Here the possession of an asset remains with the borrower itself.
In case of default by the borrower, the lender will have the right to first take possession of an asset and then sell the same to recover his amount.
The common example for hypothecation is car loans. In car or vehicle loans, it remains with the borrower but the same is hypothecated to the bank or financer.