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What is a Cash-Secured Loan?
A cash-secured loan is a loan that you take using your savings account or other assets in a share account to guarantee the loan. Whereas in a line of credit, you use assets such as your house as collateral for your loan, banks and credit unions make loans backed by savings accounts available to borrowers.
Basically, when you take out a cash-secured loan, the bank freezes the corresponding funds in your savings account while the loan remains outstanding. They will become available again after you’ve paid off the loan.
The great thing about a cash-secured loan is that you can easily qualify for it even if you have poor credit. Why? Because the lender has practically zero risks in granting your loan.
As such, they normally charge a low fixed interest rate; some would just add 1% to 3% over the dividend or interest rate that the bank pays to the depositor. Whatever interest the bank pays on your savings can help offset whatever interest you will pay on the loan.
Cash-Secured Loans: How Do They Work?
It’s fairly simple.
When you borrow from your savings account, the bank/credit union simply places a hold on the account you want to use as collateral equivalent to the amount you want to borrow.
Most banks or credit unions set a minimum of around $200 to $500 while the maximum is around 80% to 100% of your share account balance. The credit union would just issue a check for the proceeds of the loan or, in common practice, credits your checking account for the amount.
Payments for the loan will depend on your bank/credit union’s policies – some will automatically debit your checking account, others through direct deposit, or through a check payment each month. The release of the hold or availability of the funds that you’ve used as security will depend on the bank/credit union.
Some of them will release the funds progressively as you make your monthly payments. Others will require you to pay off the loan in full before you can access your funds. In each case, the bank/credit union will continue to pay interest and dividends to your frozen account.
Cash-secured loans that the bank/credit unions release in a lump sum usually carry fixed interest rates so that your monthly payment stays the same over the period of the loan.
You won’t have to worry about the risks that come with a variable rate so there are no surprise rate increases. It will be to your benefit if you can work out a low rate for several years especially if your savings start to earn more or if interest rates increase on other loan types.
However, if you use a cash-secured credit card, the lender will give you a variable rate.
Benefits of Using a Cash-Secured Loan
Here are some reasons why it’s better to use a cash-secured loan over than just using the cash in your savings account:
It Builds Your Credit
Similar to credit builder loan, this is really good if you have bad credit or no credit at all because it can help you build your credit. Every time you make a loan payment or eventually pay off a loan, the bank reports it to the credit reporting agencies.
Because of this, your credit score will get a boost. You should ask your lender to report your loan payments to the credit bureaus and later confirm that they did so by looking at your credit report. You can ask for a free credit report from each of the major credit reporting bureaus once a year, including Transunion, Experian, or Equifax.
If your focus is on rebuilding your credit, make sure the loan will achieve your objective:
- Make sure that the lender reports your payments to the credit bureaus; if they don’t, there will be no benefit on your credit scores.
- Verify your credit report periodically (it’s free) so check if the lenders are actually reporting your loan payments.
- Pay on time. Late payments will harm your credit and it will cause you to work a lot harder to improve it.
It Offsets Interest Costs
If you’re paying interest to rebuild your credit through a loan, it really helps if you can recover some of those costs through the interests that you earn from your savings. But you should only borrow and pay interest only if you will receive other benefits.
When you use your money as collateral, the bank/credit union will free your account until you pay off the loan.
Maybe you could access some of them after you’ve fully paid the loan but the good thing is that your money continues to earn interest. Of course, it will be less than what you pay on the loan but better something than nothing.
You Can Use a Cash-Secured Loan For Any Purpose
Many loans – like auto loans – have specific purposes and uses. You can use a cash-secured loan for a variety of things. Good borrowing practice, however, dictates that you should only use it to pay for something that you actually need, not want.
Protects Your Savings
If you’re the type of person who can’t manage to keep your savings account intact, a cash-secured loan will help you. In a way, the loan rewards you when you rebuild your savings through loan payments.
This means that at the end of the loan’s term you will have cash reserves that you can use in case you need them again.
Lenders for a share-secured loan will generally forego with a credit check.