A pledged asset is an asset that a borrower uses as security for a loan. The borrower gives the lender a lien on the asset, which gives the lender the right to take possession of the asset if the borrower defaults on the loan.
By pledging an asset, the borrower may be able to secure a larger loan, get a lower interest rate, or get approved for a loan that they might not otherwise be able to obtain. The pledged asset reduces the lender’s risk because the lender can sell the asset to recover some or all of the loan amount if the borrower fails to repay the loan.
Pledged assets can include a wide range of assets such as real estate, vehicles, investment accounts, equipment, or other valuable items. For instance, in a mortgage loan, the house is usually the pledged asset. If the borrower fails to make payments on the loan, the lender can foreclose on the house.
In business, a company may pledge its assets, like machinery, buildings, or receivables, to secure a business loan or a line of credit. This is common in asset-based lending. If the company fails to repay the loan, the lender has the right to seize and sell the pledged assets to recover the loan amount.
Example of a Pledged Asset
Let’s say John wants to buy a house that costs $300,000 but only has $60,000 for a down payment. To purchase the home, he takes out a mortgage loan from the bank for the remaining $240,000. As part of the loan agreement, the house itself becomes a pledged asset.
This means if John stops making mortgage payments (defaults on the loan), the bank has the right to take possession of the house, a process known as foreclosure. After foreclosure, the bank can sell the house to recoup the money it lent to John.
Similarly, let’s consider a business example. If a manufacturing company wants to expand its operations and needs a loan of $500,000, it might pledge its factory equipment as collateral. If the company fails to repay the loan as agreed, the bank could seize the equipment and sell it to recover the money it loaned to the company.
In both these examples, the house and the factory equipment are pledged assets. They serve as security for the lender, providing a way to recover the loan amount in case the borrower defaults on the loan.