How Do Share Secured Loans Work?

A share-secured loan uses the money in your savings account as collateral. Aside from providing a convenient way to borrow, share-secured loans can help with establishing and rebuilding credit when they’re repaid on time.

Here’s how to decide if a savings-secured loan is right for you.

[Read: Best Personal Loans.]

What Is a Share-Secured Loan?

A share-secured loan, sometimes known as a savings-secured loan, is a type of personal loan secured by the money in a bank account. For instance, you may be able to use a savings or money market account or certificate of deposit as collateral.

When you take out one of these loans, the bank freezes the amount you’d like to borrow. The amount remains in your account and continues to earn interest while you pay off the loan. Regaining access to your money will depend on the lender, with some releasing portions as you make monthly payments and others requiring that you pay off the entire loan.

The amount you can borrow also varies with each lender. Some allow you to borrow up to 100% of your savings balance, while others set a maximum amount. Regardless, the loose eligibility requirements are often appealing to borrowers.

“There is often no credit check required to establish this loan, and the processing time is usually faster,” says Dan Goldfarb, a senior financial advisor at Empower, a mobile app that provides cash advances.

That’s because you’re borrowing against your own account balance, which means the lender takes little risk and doesn’t need to charge a high interest rate. Typically, interest rates are a few percentage points above the rate you’re earning on your savings account.

You’ll repay the loan in monthly installments over five to 15 years, depending on your lender. If you default on the loan, the lender takes funds from your account to satisfy the debt — and you won’t get them back. Defaulting may also trigger negative entries on your credit report, Goldfarb says, which can hurt your credit score.

Why Use a Share-Secured Loan?

People often take out a share-secured loan to build credit, but these loans also have other benefits:

Establish or build credit. Borrowers use share-secured loans specifically for this purpose. Paying on time and in full every month can help you build your credit because payment history is the most important factor of your FICO score. A share-secured loan can also improve your credit mix, or the types of accounts you have, which makes up a small part of your credit score.

Save money on future loans. A share-secured loan can be used as a steppingstone to other types of credit. For example, qualifying for an auto loan or mortgage may be easier after you establish or build credit with a share-secured loan. A higher credit score may also help you get better loan terms, such as a low interest rate.

Take advantage of flexibility and convenience. Some lenders offer on-the-spot approval once they verify the amount in your savings and place a hold on the funds. Also, you can typically use loan money for any purpose.

Save on interest. You might pay a lower interest rate with this type of loan because it is backed by collateral. The interest rate on share-secured loans is often low because the lender doesn’t take on much risk, Goldfarb says.

[Read: Best Low-Interest Personal Loans]

Where Can You Get Share-Secured Loans?

Many banks and credit unions offer share-secured loans, though you’re more likely to find them at credit unions. If you’re interested in taking out one of these loans, start by asking people in your network for recommendations or checking with the financial institution where you have a savings account. You can also put into a search engine “share secured loans” or “savings secured loans near me” and check out the results.

For quick reference, here are some of the financial institutions that offer share-secured loans:

Navy Federal Credit Union.

— State Employees’ Credit Union.

— Boeing Employees’ Credit Union.

Regions Bank.

BMO Harris Bank.

Alliant Credit Union.

— America First Credit Union.

— Digital Federal Credit Union.

Credit unions are not-for-profit institutions, so they often waive fees, charge lower rates on loans and pay higher rates on savings accounts. They also tend to offer strong customer service.

The main drawback is that you must be a member of a credit union to use its products. But some credit unions provide easy paths to membership, allowing you to sign up through family or work relationships, organizations or communities.

How to Qualify for a Share-Secured Loan

The process of finding a share-secured loan, fitting the requirements and applying may vary slightly with each lender. But these are the basic steps you can expect to take:

Research lenders. Make a list of reputable lenders that offer share-secured loans, and compare their interest rates, loan limits and fees. Look into the repayment timeline and the type of collateral the lender accepts.

Check the requirements. You will need a savings account or CD with enough money to secure the loan. Lenders typically skip a credit check because the loan is backed by your savings.

Apply for the share-secured loan. This may be possible online, over the phone or in person after making an appointment. On the application, you may need to provide your reason for the loan, your desired term length, your income and your employment status. The lender may also ask for personal details, such as your Social Security number and driver’s license number.

Wait for approval. Depending on the lender, you may find out instantly whether you got the loan or have to wait. But this step is often quick. Because you’re technically borrowing from yourself rather than the bank or credit union, qualifying may hinge more on how much you have in your savings account.

Receive your funds. You may be able to apply for the loan and get your money the same day. Then you can start using what you’ve borrowed.

Pros and Cons of Share-Secured Loans

Pros

— Help you build or repair credit.

— Earn interest on your savings even while your funds are frozen.

— Offer low interest rates because of collateral backing.

— Allow you to borrow typically without a credit check.

— Usually provide quick approval and funding.

Cons

— Freeze access to a portion of your savings.

— Put your collateral — your savings — at risk if you default, which could drain your financial resources.

— Come with interest charges and potentially fees.

Is a Share-Secured Loan Right for You?

Share-secured loans have several benefits, but borrowers with weaker credit who may not qualify for a loan elsewhere may stand to gain the most. The financial institutions that offer share-secured loans often provide instant approval — with no credit check, importantly — as long as the applicant has a savings account with enough funds.

If you plan to take out one of these loans, create a repayment plan before you sign the paperwork, says Joe Pendergast, vice president of consumer lending at Navy Federal Credit Union.

Additionally, “Know exactly why you need a share-secured loan, so you don’t stretch yourself beyond your means and wipe out your savings,” Pendergast says.

Savings-secured loans aren’t the best fit for everyone, Goldfarb says. If you already have strong credit and cash reserves in the bank, he says, then this type of loan may be unnecessary.

“Generally, you should only take it out to cover the cost of necessities that you can’t afford upfront,” Goldfarb says.

[Read: Best Bad Credit Loans.]

Alternatives to Share-Secured Loans

If a share-secured loan isn’t the best fit for you, then check out these alternatives:

Credit card cash advance. If you only need to borrow a small amount and you don’t need to build credit, then you may be able to borrow the sum using your credit card. You get the money as cash upfront and then start repaying your card issuer soon after. Cash advances come with interest and fees, so check whether they’re more expensive than a share-secured loan available to you.

Credit-builder loan. This type of loan basically works in reverse of a share-secured loan, helping you save and build credit. When you take out a credit-builder loan, your lender transfers the amount you’re borrowing to a savings account. You’ll make regular payments on the loan with interest and can access the loan once you clear the balance.

Personal loan with co-signer. Applying with a co-signer who has good credit can help you qualify for the loan and obtain better terms than you might on your own. Not all lenders accept co-signers, however.

Secured credit card. You pay a deposit upfront to open the card, and your credit limit is typically equal to that amount. An on-time payment record can help you build credit, earning a bigger limit or an unsecured credit card.

More from U.S. News

What Is an Unsecured Loan?

No-Credit-Check Loan Options

How Do Personal Loans Work?

How Do Share Secured Loans Work? originally appeared on usnews.com

Update 06/20/23:

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