Last Updated on December 23, 2022 by Hooria Batool
What is hypothecation?
When a borrower takes out a mortgage using the house as collateral, it’s known as real estate hypothecation. In the case that the borrower isn’t able to repay the mortgage and promissory note, the lender may use this asset as additional collateral. Hypothecation does not give the lender any ownership rights of the asset or right to collect potential income from the property or asset, such as rent. Rather, it creates a lien on the pledged collateral that allows the lender to seize the property or asset if you default.
According to Merriam-Webster, hypothecation is the giving of something (such as property or money) as security for a loan. In other words, you get a mortgage to buy real estate and the real estate itself becomes collateral for the loan. But what if I told you that there is another, even better type of hypothecation? Well it’s not technically hypothecation but rather ‘equity was stripping’ and it involves using equity in your home to finance other investments.
There are several ways this can be accomplished:
1. Draw out cash from your home
You know how we talked about taking out a second mortgage on an investment home before? Well you can also take out cash from your primary residence. The reason this is important is because most people don’t realize they can use their home equity to finance other investments.
2. Equity stripping with a HELOC (home equity line of credit)
This allows you to draw out cash from your home without having to refinance, which saves you money in closing costs and the like; additionally, the interest paid on this type of loan might even be deductible. Your great grandparent’s house had no mortgage when they bought it so why would you need one? It’s not like houses depreciate in value. And if real estate does go down in price all you have to do is walk away. Banks aren’t really hurting in practice since foreclosures are an implicit admission that the original loan was made in bad faith, so it’s very unlikely that they would sue you.
3. Put the equity stripping plan into action and re-finance your home for even more money (repeat until satisfied)
Interest rates on mortgages are far lower than interest rates on most other investments; if you follow the 3 steps outlined above over and over again, eventually you can get enough cash out of your house to make it worth selling. This is an extremely risky maneuver however since real estate values only go up (never down), but I suppose that’s kind of like saying that there’s no greater risk than death itself. If this doesn’t sound too appealing then perhaps option 2 will be better for you.
4. Selling the house and walking
Selling the house and walking away from the loan vs foreclosure sale (non-recourse) vs taking a loss on a short sale vs hypothecation real estate with a trust deed investment or land contract.
There are three possible outcomes for this strategy:
- The most desirable outcome is that you have enough money to retire early, which means it’s time to tell your boss where he can shove his job. If you’ve been making sound investments then you might even be able to afford a comfortable retirement by supplementing your capital gains income with interest payments from trusts you set up.
- The second most desirable outcome is that your house doesn’t sell and you are able to get an extension on the deal, which gives you more time to replenish capital accounts.
- And then there’s foreclosure/bankruptcy/death. You could always just give up and declare bankruptcy but don’t think this means your plan was a failure; it simply means that you got in over your head so now’s a good time to re-evaluate your strategy if this happens.
Role of blog:
The role of this blog is to provide information, not judge anyone for how they choose to use it (and is thus suitable for all audiences; we do not encourage or condone any illegal activity). The only person that can be held responsible for misusing the knowledge contained here is yourself, and please keep in mind that ignorance of the law excuses no one. In other words: it’s your responsibility to verify everything I’ve said here before using it as investment advice.
But if you insist on being a cheap bastard then don’t say I didn’t warn you. If at first you don’t succeed then maybe all those ridiculous hypothecation real estate schemes were too conservative for your
How is real estate hypothecation used?
When commercial lenders underwrite a commercial mortgage, they frequently want additional assets to be pledged or hypothecated. These may be another investment property or your primary home.
When a borrower seeks a loan from a bank and the lender is concerned with certain details of the loan, such as borrower qualifications or history, loan-to-value ratio, debt-to-income ratio, or net worth, among other things, this is known as hypothecation. Pledging more collateral may help to balance these ratios and make the loan more appealing to the financial institution to invest in.
Hypothecation may also be used when a property owner requests an unsecured loan or to assist lower an interest rate to one that is more favorable. Lenders looking for assets that can be hypothecated are seeking for equitable title, which means you can hypothecate a property or asset even if there is an outstanding mortgage or debt as long as there is enough equity.
Real estate lending transactions often involve hypothecation, which involves using a property to secure a loan. Additionally, it can be used for investing and other types of loans. Unless you understand the potential consequences if you default on your loan obligations, you shouldn’t enter into a hypothecation agreement.