savings

Passbook loans: Paying to borrow your own money

If you need money, the cheapest way to go is to use funds from a savings account that's earning 1 percent. You're not losing much in the way of interest. But when saving money is such a hard-learned discipline, it can be gut-wrenching to spend it. Some just hate to see the balance drop; others are worried they'll never again have the discipline to replenish the account. So, instead of borrowing the bank's money for whatever the going rate is, they pay 3 percent to borrow their own. It certainly beats paying double that for an unsecured bank loan, and they get some self-enforced discipline to boot.

"They need the bill every month to repay the loan," says Joan Reydel, loan officer at Hingham Institution for Savings in Hingham, Mass.



But there is a downside. If an unexpected expense comes along that must be paid you might find it necessary, or at least tempting, to default on the passbook loan.

"If you can't pay, we're going to close your account and get our money back," Cesario says. "We've had to do it a few times. We give them a long time to pay it back before we pull the trigger, but sometimes we do pull the trigger and close out the account for the balance of the loan."

This illustrates the danger of a passbook loan if your savings account and your emergency fund are one and the same. An emergency fund shouldn't be used for anything but true emergencies -- loss of a job, unexpected medical expenses, etc. Buying a new TV or replacing the old washing machine that finally conked out doesn't count.

Even if you aren't in danger of defaulting on the loan, your savings account, up to the balance of the loan, is collateral and you have no access to those funds. So, if it's your emergency fund and a crisis arises, you have no money.

If your savings account is short of the minimum emergency fund goal of three months' living expenses, it might be safer for your long-term financial health to borrow via a regular bank loan. You'll pay more interest, but you'll keep your emergency fund intact.

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