What does pledging mean in a loan?

The alternative we're reviewing today is that of pledging one of our assets. Let's see what that entails.

Although the term is not very common, pledging simply means providing one or more of our assets as collateral, thereby 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, if a customer fails to make repayments, the bank can exercise its right to take possession of the pledged asset and, in this way, recover its money. Therefore, it is 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.

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The first difference is that the pledged asset passes into the hands of the lender (i.e., it is offered as collateral). Therefore, you cannot use the pledged asset in any way for the duration of the loan term. 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.

Also, unlike a mortgage, pledging lets you offer a wide range of physical or financial assets as a guarantee of repayment. What's more, you can offer one or several assets, provided the total amount equals the loan value. 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 the borrower is unable to face the debt at some point, the lender can put the pledged asset on a public auction to recover the borrowed money. If they were financial assets, the lender may execute their rights (such as selling stocks) to recover the capital.
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When is it a good idea to pledge an asset?

Pledging can facilitate access to financing both for individual customers and companies. Also, it is a useful way to offer robust 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 repayment guarantee method 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.

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