Although the term is not very common, pledging is simply providing one or several of our assets as collateral, thus offering an additional form of repayment guarantee, usually to a lender. It is a formula used in banking to ensure financial operations, for example in loans when the applicant’s profile does not offer all the necessary guarantees that they will be able to repay the money lent.
Therefore, in the event of the customer failing to make repayments, the bank would be able to execute its right to take possession of the pledged asset and thus recover its money. It is, therefore, another resource that the bank or the entity lending the money has to ensure it will recover the capital, even if it is in the form of an asset. Although the way this system works might seem similar to the guarantee in a mortgage, where the bank will repossess the home if the installments are not paid, there are important differences that are worth knowing.
The first is that the pledged asset passes into the hands of the lender, just as ‘providing’ the asset to the lender as collateral implies since during the term of the loan we will not be able to use the pledged asset in any way. If, for example, we had pledged our car to get a loan, we would not be able to drive it, sell it, rent it, etc. Really, the vehicle would be physically held by whoever has granted us the loan.
Moreover, unlike a mortgage, when pledging is used we can offer a wide range of physical or financial assets as a guarantee of repayment and it can be either one or several assets, provided they amount to the value of the loan we are being granted. We previously mentioned a car, but it can equally be a house, premises, a block of shares, the money deposited in an investment fund or even a set amount of capital. It is, in essence, a guarantee.
It is worth pointing out that if a financial product that generates interest or income is pledged, the customer can usually have access to that money since it would not form part of the repayment guarantee.
What happens if the loan is not repaid?
In the case of repaying all the loan without incidents, the customer recovers their pledged asset. However, if a moment comes in which it is impossible to tend to the debt in a normal way, the lender may offer the pledged asset in a public auction in order to recover the money lent. If they were financial assets, the lender may execute their rights (such as selling stocks) to recover the capital.
When can pledge an asset to be of interest?
Pledging can facilitate access to financing both for an individual customer and for a company, and it is a useful way to offer real repayment guarantees to possible lenders. For example, if our volume of income or our guarantor does not offer all the requirements that the banking institution asks us for, we can choose to pledge that business premises that we don’t use or that investment fund that we don’t need to cash in immediately. This way, we are offering another repayment guarantee that can help us to achieve that loan we want or to improve the conditions of the loan.
On the other hand, the costs of using pledging as a method of repayment guarantee are generally lower than those involved in a mortgage. When a home is mortgaged, there are a series of bureaucratic costs, such as Stamp Duty (AJD) or the valuation of the home itself.
As a final thought, it is worth carefully considering what asset you are going to pledge, since we will not be able to use it in any way during the term of the loan, with the evident inconveniences that this can entail.