What is a share secured loan and how does it work?

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Share secured loans are loans that use the balance in your savings, instead of your credit score, to back up the loan. They are a good opportunity to rebuild your credit, because even if you have poor credit history, you have a good chance of qualifying. By establishing good credit, you will have an easier time achieving your financial goals, whether that’s buying a car, purchasing a home or opening a credit card.

What are share secured loans?

A share secured loan uses the assets in a share account, otherwise known as a savings account, to back up the loan. Both banks and credit unions offer loans backed by savings, which may also be called “passbook loans.”

When you take out share secured loans, the equivalent assets within your savings account are frozen and become available again as you pay off the loan. The maximum you’re allowed to borrow varies from bank to bank. Some lenders may allow you to borrow the full amount in your savings account or a percentage. The money is repaid in monthly installments that are generally spread over five to 15 years.

Because they offer little risk to lenders, share secured loans typically come with low fixed interest rates, often 1 percent to 3 percent over the dividend or interest rate paid to the account by the bank.

How do share secured loans work?

A share secured loan is secured by your savings account, share certificate account or money market account. When you’re approved for a share secured loan, your lender will place a hold on the savings amount you’re borrowing against.

You can repay the loan through monthly automatic withdrawals, direct deposit or monthly check. If you fail to repay the loan, the savings your lender is holding as collateral will typically be used to cover the loan.

Although your savings is used to back up the loan, you should avoid making late payments or defaulting. This may cost you penalties or late fees and can hurt your credit history, since share secured loans are reported to the credit bureaus.

If building credit is your goal when seeking a share secured loan, consider taking out a small amount that is easier to pay off quickly.

Who are share secured loans best for?

Share secured loans are designed primarily for those who are seeking to establish or rebuild credit. If the loan is reported to the credit bureaus, making monthly payments on time can help improve your credit profile.

Additionally, for consumers who have less-than-stellar credit, this type of loan can be easier to qualify for than a traditional personal loan.

“The lending institution knows the borrower has the collateral in their savings account. So, the bank is taking very little risk,” says Daniel Milan, managing partner of Cornerstone Financial Services.

Get pre-qualified

Answer a few questions to see which personal loans you pre-qualify for. The process is quick and easy, and it will not impact your credit score.

Why use share secured loans?

There are a number of reasons to use share secured loans instead of taking out cash from your savings account:

  • Build credit. If you have bad credit or no credit at all, these loans can help you build credit. Every time you make loan payments or pay off a loan, it will be reported to the credit reporting agencies, and your credit score should receive a boost. Ask your lender to report loan payments to the credit bureaus, and verify that it did so by checking your credit report. Each year, you can ask for a free credit report from each of the major credit reporting bureaus: TransUnion, Equifax and Experian.
  • Save on future loans. While share secured loans may cost you some money in interest payments now, a higher credit score should allow you to save money through lower interest rates on loans in the future.
  • Use for any purpose. Unlike specific kinds of loans — like auto loans tied to cars — you can use share secured loans for a variety of things. The general rule of thumb, however, is that you should only use them to pay for something you really need and can’t afford up front.
  • Protect savings. If you have a hard time staying disciplined when building your savings, share secured loans may be right for you. The loan incentivizes you to rebuild your savings through loan payments, so at the end of the loan’s term you will have cash reserves that you can fall back on should you need them again.

While using your savings account as collateral may seem riskier than taking out an unsecured loan, share secured loans offer real opportunities to rebuild credit and improve your financial future. If you opt for an unsecured loan instead, compare rates online before applying.

You can get an idea of how much you’ll pay each month using a loan calculator.

What to watch out for

If you’re considering a share secured loan, keep in mind that there are some potential drawbacks or risks associated with this type of borrowing.

For instance, the savings you use as collateral will be frozen until you repay the loan in full, so you won’t have access to the funds. If you default on the loan, your savings account will likely be used by the bank to pay off the installment loan balance, Milan says. “This could wipe out your household’s rainy-day fund.”

As with any type of loan or credit application, be sure to read the fine print and review all of the terms of the agreement before signing on. Make sure you understand the true cost of the loan, including any up-front costs or annual fees, to ensure that you can make loan payments on time and avoid defaulting.

“Make sure the payment fits within your budget,” says Katie Bossler of GreenPath Financial Wellness. “The number one factor of a credit score is paying bills on time, so if the purpose of the loan is to build credit, it’s important for the consumer to make sure that the monthly payment will fit into the budget and can be paid on time each month.”

How to qualify for a share secured loan

Because you’re essentially borrowing from yourself, qualifying for a share secured loan is typically a simple process. Assets in your savings or CD account will be used as collateral for the loan.

While your credit score may not be a factor in approval, it could impact the interest rate you pay on the loan. The higher your credit score, the lower your interest rate may be.

Terms and conditions

The terms and conditions of share secured loans vary from lender to lender. Many lenders allow you to borrow up to 100 percent of your savings or CD balance, while others allow you to borrow a percentage of what you have deposited.

Interest will be charged on the money borrowed. Typically, the rate is based on the interest or dividend paid by the lender to your savings or CD account plus 1 percent to 3 percent. For example, if your savings account has an APY of 1 percent, you may pay interest of 2 percent to 4 percent.

The repayment timeline for a share secured loan also varies by lender and amount borrowed, but it is generally from five to 15 years.

Get pre-qualified

Answer a few questions to see which personal loans you pre-qualify for. The process is quick and easy, and it will not impact your credit score.

Alternatives to share secured loans

If you’re looking to meet short-term financial goals or improve your credit score, there are other options available besides share secured loans.

Similar to a share secured loan, a secured credit card is attached to a deposit account. The credit limit is the same amount deposited into the account. If you don’t make the agreed payments, the money is removed from the account.

A credit-builder loan also works like a share secured loan, but you pay off the loan before you can access the money. The lender you choose will deposit the funds into a savings account. When the loan is paid off, you’ll have access to the money. This makes the credit-builder loan better suited for long-term needs.

A secured personal loan is backed by an asset you already own, such as a car, boat or RV. If you default on the personal loan, the lender can seize your property to recoup its losses.

Next steps

A share secured loan can be a good option to consider if you’re seeking to establish or rebuild credit. Although there’s a cost to taking out this kind of loan, it may make sense if your goal is to eventually obtain other kinds of credit that are more difficult to qualify for, such as a mortgage.

Just be sure when using this kind of loan that you understand all of the terms and conditions, and check with your lender to confirm that the loan will be reported to credit bureaus.

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