Anyone who has an auto loan or mortgage has likely entered into a mortgage agreement to secure the loan. Mortgage loans are common with secured loans.

In the case of a mortgage on an unmortgaged home, a borrower could default on the mortgage and still be able to keep the home. No financial institution would be willing to lend at such a risk that most people would not be able to buy a house without the necessary cash. The pledge enables lending and borrowing.

For borrowers unsure what a mortgage is, here is a look at what the term means and why it benefits both borrowers and lenders.

What is hypothesis?

Pledge is the pledging of an asset as collateral to secure a loan. The borrower does not transfer ownership of assets to the lender, but if the borrower fails to make its loan payments according to the loan terms, the lender can take possession of the asset to make up for its loss.

With a home or car loan, this can mean foreclosure or garnishment for the borrower. For most mortgages and auto loans, pledging is a standard requirement.

Pledge is only used on secured loans such as secured personal loans and mortgages. Often with this type of loan, the asset pledged as collateral has nothing to do with the purpose of the loan other than to secure it. For example, a borrower can pledge jewelry, a vehicle, or even stocks or bonds as collateral for a secured personal loan.

Mortgages are also used in investing when investors buy on margin or short stocks. Short selling involves borrowing securities and requiring the investor to open a margin account to post as collateral. Margin buying involves borrowing money from a broker or bank to buy securities. Typically, the investor pledges securities or other assets as collateral.

How does mortgage lending work?

Here’s a closer look at how mortgage loans work for securing a mortgage or car loan and investing.

Pledge for mortgages and car loans

When borrowers enter into a loan agreement, they undertake to repay the loan as specified in the loan agreement. However, a bank or lender doesn’t risk lending thousands of dollars without one of two things: collateral high enough to cover the loan or an extremely high interest rate. Lenders need a way to recover their loss when a borrower defaults.

The borrower mortgages the home or vehicle in exchange for a lower interest rate. If the borrower continues to make payments on time, they can live in the house or drive the car used to secure the loan.

However, if the borrower defaults on the loan, the loan agreement gives the creditor the right to pledge the pledged property or repossess the pledged car. The lender can then sell the home or car to recover the money that the borrower failed to repay.

Mortgages for Investment

Mortgages work in a similar way to investing.

A broker will not lend money to an investor to buy on margin without a guarantee that they can get their money back if a margin call occurs and the investor suffers a loss. Thus, an investor can pledge other securities they own as collateral.

The investor keeps any profits from the securities bought on margin, but in the event of a loss, the broker can take possession of the pledged securities and sell them to make up the loss.

Why should borrowers care about mortgages?

Mortgage loans are an essential lending tool and likely make lending possible by eliminating most of the risk for lenders. Since the lender can use the collateral to cover any loss that the borrower may default, not only is it willing to lend money, but it can do so at an affordable interest rate. Because of this, secured loans can have much better interest rates and terms than unsecured loans.

This is of course important to borrowers as it often means for a borrower the ability to obtain credit approval on a high quality asset at an affordable rate.

However, the borrower must understand that missed payments or a loan default will result in the lender seizing the pledged asset.

Bring away

Pledge is the pledging of collateral to secure a loan and can be a double-edged sword for borrowers.

By pledging collateral, the borrower can usually obtain reasonable loan interest and terms, allowing them to own and use a home, vehicle, or other high-value asset while paying off the loan. However, this also allows the lender to seize the item if the borrower defaults.

When entering into a loan agreement, it is crucial for the borrower to understand all of the loan terms and determine if a mortgage is applicable. This applies when you take out secured loans or investor credit for margin trading and short selling with a brokerage account.