Cash Secured Loans

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Need to improve your credit? A cash secured loan might help. The idea probably seems strange: borrow against your savings in the bank, and pay more interest on the loan than you’re earning on savings. But there are a few reasons to look at using your own cash to secure a loan. These loans are especially helpful for building strong credit, and they can also help you manage your behavior.

What is a Cash Secured Loan?

A cash secured loan is a loan that you “qualify for” based on cash that you’ve already given to the lender.

You’ll borrow from the same bank or credit union where you have money in a savings account, money market account, or certificate of deposit (CD).

Because you have the money available in your account, there is very little risk to the lender. You’ll pledge that cash as collateral, meaning the lender can take the funds out of your account if you fail to repay the loan. As a result, you’ll have an easier time getting approved. If you can’t qualify for other types of loans (such as unsecured loans or credit cards), cash secured loans might be a good idea.

Why not Spend your own Money?

You might wonder if there’s any point in getting a loan when you’ve already got the cash available. In many cases, spending your own money is a fine option: you’ll avoid paying interest, and you don’t risk any damage to your credit if you stop making payments.

However, getting a loan might be helpful. If you’ve got bad credit (or you’ve never borrowed in the past so you’ve got “thin” credit), these loans can be a stepping-stone towards higher credit scores.

Every time you successfully pay off a loan, your credit improves (assuming the loan is reported to the credit reporting agencies).

When you use your cash as collateral, the money gets locked up until the loan has been repaid (you might be able to access some of it after you’ve partially repaid the loan).

In the meantime, it continues to earn interest. You’ll earn less interest than you pay on the loan, but those interest earnings can help offset your costs.

There’s also a behavioral benefit. If you have a hard time saving money, it might not be a good idea to blow out your emergency savings (because then you’ll need the discipline to rebuild). Borrowing against your money provides a structure that encourages you to make the required payments, and discourages you from using credit cards to pay for emergencies.

Ultimately, the difference between what you earn and what you pay is the price of improved credit and the psychological benefit. If you use bigger loans in the future – to buy a house or car, for example – the strategy can pay off. A slightly better rate (due to your higher credit score) on a large loan can result in significant lifetime savings.

How they Work

Use for anything: cash secured loans can be used for any purpose. But it’s best to put the money towards something that you really need or that will bring a return on your investment (such as a new furnace).

Competitive rates: the interest rate you pay on a cash secured loan is lower than what you’ll pay for most other loans.

Unless you have great credit, you’re better off using these loans than credit cards or personal unsecured loans. Again, the risk to your lender is small, so the cost to you is lower.

Fixed rates: interest rates are typically fixed, so your payment remains the same over time. You don’t take the same risks that come with a variable rate, such as surprise payment increases. Especially if rates are low, getting a fixed rate for several years can work in your favor if your savings start to earn more.

How much? Some banks let you borrow the full amount that you’ve deposited and pledged as collateral. Others limit the loan to value ratio to around 90% (or less). For example, for every $100 in your account, they might only allow you to borrow $90.

Short terms: most cash secured loans come with relatively short terms – 10 years or less is common.

These loans are best used to get you through tough times and beef up your credit score. If you’re looking for a 30-year mortgage, wait until your credit improves.

Installment payments: to repay your loan, you’ll usually make equal monthly payments over the term of your loan. A portion of each payment reduces your loan balance, and the remainder is your interest cost. To see how that process works, read about amortization. Look over some numbers for yourself with our loan calculator.

However, there are variations on the standard loan. Some loans are available in the form of secured credit cards or other types of lines of credit.

Relatively small: you don’t need to go big to take advantage of these loans. If your credit could use a tune-up, ask about borrowing a few hundred dollars. This will be less burdensome on your finances (you don’t want to lock up any more money than you have to, and you can keep interest costs low).

To Improve your Credit

If your main goal is to rebuild credit, make sure the loan will actually work in your favor. Ask your lender if payments are reported to the credit bureaus, and verify that the loan is actually reported by checking your credit periodically (it’s free). Finally, get your payments in on-time – late payments will harm your credit.