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In case you take out a loan using your share funds as collateral, it classifies as a share secured loan. Share secured loan can be an invaluable tool in establishing or rebuilding your credit history. You can also use them to consolidate your debts at a lower rate and to finance your purchases without actually dipping into your savings account.
A share secured loan is an indebtedness that uses the assets in a share account (mostly savings account) to guarantee a loan.
Banks and credit unions accept savings account as collateral to back up a loan. When you avail of a share secured loan, the bank or credit union freezes the commensurate funds within your savings account, but they will unfreeze them as you begin paying off the loan.
The great thing about share secured loans is that even if you have poor credit, you can easily get loan approval.
This is because, on the lender’s part, there’s practically no more risk. What’s more, they often feature a low fixed interest rate – ranging from 1% to 3% over the dividend or interest rate that the bank pays to savings accounts. Another helpful thing is that you can opt to use the interest that you will earn from your savings account to help offset the cost of your loan.
How It Works
In a share secured loan, the bank/credit union ‘holds’ the amount from your savings account that you want to borrow against. They often set the minimum at $200 to $500 while the maximum that they allow is between 80% to 100% of your share account balance. The lender releases the proceeds by issuing a check to the borrower or, as is the common practice, by depositing the funds into the borrower’s checking account.
Payment will depend on your bank/credit union’s policies but often you have to authorize them to automatically deduct the monthly payment from your checking account, or directly pay the bank/credit union, or send them a check every month.
The release of the security will also vary according to the bank/credit union. Some will make the funds available in direct proportion to the loan principal that you pay off every month.
Other banks/credit unions will wait until you have paid your loan in full before they release your savings account. In any case, even while your funds are put on hold by the bank/credit union, they will continue to earn dividends.
Normally, lenders will charge a fixed interest rate for a share secured loan that you take in a lump sum so that your monthly payments will remain constant over time. You protect yourself against the interest rate risk that comes with a variable rate loan such as sudden payment increases.
A low rate will work in your favor for a long time because paying low for several years can help you save more money in your account. Also, you won’t have to worry if interest rates go up on other loan products. On the other hand, if you use a cash-secured credit card, the lender will use a variable interest rate.
When will the funds I am using as collateral be available for me to use again?
As to when your savings account would become available again, well, the practice differs between banks. Some credit unions and banks will release the funds in predetermined amounts according to a schedule when you make your monthly loan payments. Others will require that you finish paying off your entire loan before they lift the hold order on your account.
Your shares will continue to earn dividends even while your funds have been put on hold, regardless of your bank/credit union’s policy.
There are a lot of good reasons for using a shared secured loan instead of merely using the money you have in your account. These are:
It Helps Build Credit
If you have bad credit or you’re someone who is just starting to build one, these loans can help you tremendously. Each time you make your monthly payments or when you pay off your loan, the bank/credit union will report the transaction to the credit reporting agencies. And since these are positive actions, they will boost your credit score. Always ask your lender to report your loan payments to the credit bureaus, and check if they do so by getting a copy of your credit report. Every year, you can get a free credit report from each of the major credit reporting bureaus that include Equifax, Experian, and TransUnion.
If you are trying to rebuild your credit, make sure that your loan achieves that purpose by:
- Make sure that your lender reports your payments to the credit bureaus because if they don’t, there’s no benefit on your credit scores.
- Verify that they are actually reporting the payments by checking your credit regularly – anyway, it’s free for U.S. consumers.
- Always pay on time because paying late will harm your credit and when that happens, you have to work harder to rebuild it.
Offset Your Loan Interest With Your Savings Interest
Suppose you’ve taken a share secured loan just to rebuild your credit, it makes perfect sense to pay as little interest as you can possibly can. Well, you can cushion whatever interest expense you will pay through the interest you will earn from your savings account. Good financial sense dictates to borrow and pay interest only if you are going to receive other benefits.
Remember that while your loan is outstanding, your bank/credit union will keep your money in the savings account on hold.
If your lender allows it, you might be able to use some of the amounts that correspond to whatever you have partially paid off. But in the meantime, whatever you’ve left in your account will continue to earn interest. It would definitely be a lot less than what you’re paying for your loan, but it will help.
Loan For Any Purpose
Some lenders grant on-the-spot approval for a share secured loan. Your bank/credit union just needs to check how much you have in your savings, approve the loan and put a hold instruction on the funds you’re using as collateral for your loan. Some loan products have specific purposes such that you can only use the proceeds for those purposes. For example, you can only use auto loans to purchase vehicles. A share secured loan is more flexible because you can use it for almost anything.
Here’s a piece of advice though: use it only to pay for something that you really need.
Get Better Loans in the Future
Yes, you will pay more interest than what you will earn, but you can reap other advantages from the loan such as improved credit and psychological benefits. This could set you up for a bigger and better variety of loans in the future to finance your house or car, or probably even your own business.
Think about it: you can have better credit and have more cash on your account because you’ve preserved your savings account. You can use the cash for a large down payment for your house and your good credit can help you negotiate for a better rate on those larger loans. The lower rate can reduce your total interest costs in the long run.
Protects Your Savings
If you’ve been trying all your life to build some savings without much success, a share secured loan could be the right solution. The loan ‘forces’ you to discipline yourself to rebuild your savings through your loan payments.
Ideally, at the end of the term, you will have enough cash reserves on your savings account that you can keep on using as security should you need them again.
In a share secured loan, you are basically borrowing your own money. Therefore, the lender doesn’t focus on the credit aspect of the loan to grant approval. This means that they will not turn you down based on a poor credit score or lack of credit history. However, they will still consider these factors when computing for your interest rate and loan amount. Other requirements may include:
- Your membership with the bank/credit union
- Meeting the minimum share account balance
- Your consent to disclose the purpose of the funds for any loans over $10,000, per the Bank Secrecy Act.