How Cash-Secured Loans Work

Handshake upon loan approval at bank
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Building credit can be hard when you’re just getting started or recovering from financial difficulties. But a cash-secured loan might help you qualify for a loan that helps you improve your credit. At the same time, you preserve cash in an account that you can use later. The concept may sound unusual because you borrow against your savings in the bank, but these loans can be a win-win for everybody.

The loan will cost more in interest charges than the money you’re earning in interest on your savings, but with small dollar amounts, the benefits over your lifetime can outweigh the costs.

What Is a Cash-Secured Loan?

A cash-secured loan is a loan that you qualify for by depositing funds with your lender. Because the lender already has a guarantee, they may be willing to approve you for the loan more easily. If you stop making payments on the loan, the lender keeps your deposit (or a portion of it) to pay off your debt.

To use this type of loan, you borrow from the same bank or credit union where you keep your money in a savings account, money market account, or certificate of deposit (CD). You can ask about cash-secured loans at the bank you currently use or open a new account.

Since you already have the money available in your savings account, the lender takes minimal risk by approving your loan—your spending limit should be no higher than the amount of cash in your account. The lender requires you to pledge your cash savings as collateral, meaning that they can take possession of the funds if you fail to repay the loan as agreed.

If you can’t qualify for other types of loans, such as unsecured loans or credit cards, cash-secured loans might provide a way to start improving your credit.

How This Financing Works

Use for anything: You can use cash-secured loans for any legal purpose. You might put the money toward something that you really need, or something that will bring a return on your investment, such as home improvements. The loan can come in the form of a lump sum deposit to your checking account, or you might receive a line of credit with a cash-secured credit card.

Competitive rates: You still pay interest even though your lender already has assets to guarantee the loan. However, you benefit from a lower interest rate on a cash-secured loan than what you’d pay for most other loans.

If you have low credit scores, you should get a better rate with these loans than with credit cards or personal unsecured loans. Because you've secured the loan with your savings, the lender takes a smaller risk, making the cost to you lower.

Fixed rates: Cash-secured loans that you take in a lump sum typically have fixed interest rates, so your payment remains the same over time. You don’t have the same risks that come with a variable rate, such as surprise payment increases. If you can get a low rate, having that fixed rate for several years can work in your favor if your savings start to earn more or interest rates rise on other loan alternatives. If you use a cash-secured credit card, the rate will be ​variable.

Loan amount: Some banks let you borrow the full amount you deposit and pledge as collateral. Others limit the loan-to-value ratio to around 90 percent or less. For example, for every $100 in your account, the lender might allow you to borrow $90.

If your primary goal is to build credit, you don’t need a massive loan. Several thousand dollars should be plenty, and it’s common to start with loans smaller than that. Some banks offer cash-secured loans for up to $100,000, but the maximum amount depends on your bank or credit union.

Short terms: Most cash-secured loans come with relatively short repayment terms, such as ten years or less. These loans can best help you through tough times while improving your credit scores. If you’re looking for a 30-year mortgage, though, using a cash-secured loan probably does not make sense.

Installment payments: To repay lump sum loans, you typically make equal monthly payments over the term of your loan. A portion of each payment reduces your loan balance, and the remainder covers your interest cost.

To see how that process works, learn about amortization. Run the numbers for yourself and plan out your loan. Some lenders offer additional options like secured credit cards or other lines of credit.

Relatively small: You don’t need to go big to take advantage of these loans. If you’re just starting to build or rebuild credit, ask about borrowing a few hundred dollars. A smaller loan is less burdensome on your finances. You only lock up as much money as you have to, and you can pay lower interest costs over time.

Why Not Just Use Your Own Money?

You might wonder why you should bother with a loan when you’ve already got the cash available. In some cases, just spending the money makes sense since you’ll avoid paying interest, keep your debt level lower, and avoid damage to your credit if you stop making payments.

Still, you can benefit from these loans in several ways:

Build credit: If you’ve got bad credit or you’ve never borrowed in the past (known as “thin” credit), these loans can be a stepping stone towards higher credit scores. Every time you successfully pay off a loan, your credit improves—as long as your lender reports the loan to the credit reporting agencies.

Offset interest costs: If you choose to pay interest to rebuild your credit through a loan, it’s beneficial to make up for some of those costs by earning interest on your savings. It makes sense, though, to borrow and pay interest only if you’re getting other benefits.

When you use your cash as collateral, the money gets locked up until you pay off the loan and close your credit account. You might be able to access some of your money after you partially repay the loan, but in the meantime, your money continues to earn interest, although less interest than you pay on the loan.

Keep savings intact: There’s also a behavioral benefit. If you have difficulty saving money, it might not be a good idea to use up your emergency savings because you’ll need the discipline to rebuild, and you’ll have to start from zero.

Borrowing against your savings provides a structure that encourages you to make the required payments, and discourages you from using credit cards to pay for emergencies. Once you pay the loan off, you still have a sum of cash available for future needs.

Better loans in the future: Ultimately, the difference between what you earn on savings and what you pay on the loan should buy you better credit and potential psychological benefits. You may qualify for lower interest rates on significant loans in the future—to buy a house or car, for example.

With improved credit and cash available for a large down payment (because you kept your savings intact as collateral), you may qualify for better terms on larger loans. Low rates and better options can result in significantly lower lifetime borrowing costs.

Using the Loan to Build Credit

If your primary goal is rebuilding your credit, make sure the loan works in your favor:

  • Select a lender that reports payments to the credit bureaus. Otherwise, your credit scores won’t change.
  • Verify that the payments are actually reported by checking your credit periodically (it’s free for U.S. consumers).
  • Always pay on time since late payments will harm your credit, leaving you with more “repair” work to do later.