Savings Book Loan: Pay to Borrow Your Own Money

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If you need money but don’t have a strong credit history, a savings account loan can help you meet both needs. Passbook loans — sometimes called mortgage savings loans — are a type of secured loan that uses your savings account balance as collateral.

Offered by financial institutions such as banks and credit unions, these loans can be a convenient way to borrow money while you rebuild your credit. But this type of credit also involves considerable risks.

Learn how passbook loans work and the pros and cons of taking on your own money.

How does a savings account loan work?

To be eligible for a savings book loan, you must have a funded savings account or a certificate of current account. This account is usually with the institution you want to borrow from.

The amount of the savings book loan depends on the balance in your savings account. Banks then use your savings account balance as a guarantee for the loan. If you do not repay the loan, your savings will be offset against the loan balance owed.

Your lender will place a savings account hold on the amount you borrowed for the savings account loan. During this time you will not have any access to this sum. However, the blocked savings funds continue to earn interest at the usual annual percentage rate.

If you make installments on the loan, the bank releases the same amount from your retained savings. When you have repaid your loan in full, your savings collateral is 100 percent available to you again.

Should you take out a savings account loan?

Why would anyone pay to borrow their own money? Why not just use the money in the savings account?

One reason is create credit. If the goal is to improve your credit profile, it’s a good idea to check with your bank to see if they report passbook loans to Experian, Equifax, or TransUnion before proceeding.

For some borrowers, this can also be a psychological reason. Some people hate it when their savings account balance goes down; others fear they will never have the discipline to top up the account again. Instead of draining their savings account, some people prefer to take out a savings account loan.

If you have a strong credit rating, the financial risk is unnecessarily on you and not on the financial institution when you borrow against your own money. A low-interest unsecured loan or a 0% APR credit card could be an alternative. However, if borrowing money is the best way to improve your credit, a savings account loan may be an option to consider.

What are the pros and cons of borrowing from your savings?

There are a handful of advantages that passbook loans can offer, but there are still some disadvantages to be aware of.

advantages

  • Lower interest rates. Savings account loan interest rates are typically just 2 percent APR, compared to the average unsecured personal loan rate of 10.49 percent.
  • Minimum requirements. Because taking out a loan with a savings account serves as collateral, the loan requirements and approval are less stringent.
  • Helps rebuild credit. Making consistent, timely payments throughout the life of the loan can improve your credit score. If this is your primary reason for taking out a savings account loan, ask if the lender reports payment activity to the credit bureaus.
  • Earn savings interest. The part of your savings held by the bank just keeps getting more interesting. This can easily reduce the overall cost of taking out a savings account loan.

Disadvantages

  • Cannot improve your credit score. It does not always make sense to rely on savings book loans when building up credit, since not all lenders report these payments to credit agencies. Also, your credit will be affected if you make late payments on your savings account loan.
  • No safety net in case of emergency. If an unexpected expense occurs and you have to pay it, you risk defaulting on the savings account loan. Even if you are not at risk of defaulting on a loan, you do not have access to all of your savings. If this is your only emergency fund and a crisis arises, you have no money.
  • You pay to borrow your own money. Ultimately, any loan amount that you are approved for means that you already have those funds in your savings account. You pay the bank for permission to use your own funds.

The final result

Savings account loans may seem like an attractive option on the surface, but be careful. Because the loan is secured in whole or in part by your savings, you have limited access to your savings until the money you borrowed is repaid. In addition, you are responsible for paying interest on your own money, and late payments can damage your credit score.

If you’re looking for the best way to borrow money, it’s important to do your research on when choosing the right loan for you.

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