How Do Share Secured Loans Work?

A share secured loan, also called a savings secured loan, is designed for short-term borrowing needs and uses your own money in a savings account as collateral. Aside from providing a convenient way to borrow, share secured loans can help with establishing and rebuilding credit when they are repaid on time.

Here’s how to decide if a savings secured loan is right for improving your credit.

How Savings Secured Loans Work

Share secured loans use an interest-bearing account — savings, money market or certificate of deposit — as collateral. They’re sometimes called share secured loans because they first became popular at credit unions, which refer to members as having shares of the institution. However, banks and other lenders may call them savings secured loans.

“Nowadays, there are many companies that deal in this, so you can simply go online and search for share secured loans, and compare them to find the one that has the best terms,” says Michael Sullivan, consultant in personal finance for Take Charge America, a nonprofit financial counseling agency. Using your money as collateral, the lender gives you a lump sum payment, charges you interest and keeps track of your payments. “The important part is they will report your payments to the credit bureaus,” says Sullivan.

[Read: Best Bad Credit Loans.]

The drawback, however, is you can’t use the money from your savings account again until you pay the loan back. “That’s why a share secured loan really doesn’t make sense other than for building credit,” says Sullivan.

“With a savings secured loan, you pledge your savings account as collateral to back up the loan,” says Joe Pendergast, vice president of consumer lending at Navy Federal Credit Union. “Your savings still earns dividends and becomes available if you make on-time monthly payments towards the loan.”

If you fail to repay the loan, the lender can keep your savings to satisfy the debt. Plus, you’d be defeating the whole purpose of the loan, says Sullivan. “If you mess up with your payments, it has the opposite effect on your credit. You’ve got to pay it off as the terms require.”

Pendergast recommends setting up automatic payments to ensure you make on-time payments each month. “In the long run, this’ll help boost your credit score and give you a stronger credit profile for when you need to apply for other loans in the future,” he says.

Banks and credit unions can set different loan limits. For example, the maximum might be up to 100% of the balance of your savings or CD account, while the minimum can vary by institution and loan length. At Navy Federal, for example, savings secured loans with term lengths of 60 months or longer require a $25,000 to $30,000 minimum loan amount, says Pendergast.

Why Use a Share Secured Loan?

The primary reason to get a share secured loan is to build credit. Here’s why:

— A share secured loan is a type of installment loan that’s easier to qualify for than other products. Making installment loan payments on time can help raise your credit score, as payment history carries the most weight in credit score calculations — accounting for 35% of your FICO score.

— An installment loan can also help your score because it improves your credit mix. Credit mix — meaning the types of credit you’re using — makes up 10% of your score. Credit-scoring models look favorably on people who use both installment loans and revolving credit accounts, such as credit cards, responsibly. If you already have a credit card, adding a savings secured loan to your credit history and paying it on time could add points to your score.

— A share secured loan could also be used as a steppingstone to other types of credit. For example, if you want to buy a car, building your score with a share secured loan could make qualifying for an auto loan easier.

— Savings secured loans can provide you with some cash flow in a convenient way, with no origination fees (as you may be charged with a home equity loan, for example). You can use them for almost anything, including debt consolidation or small home improvement projects.

How to Qualify for a Share Secured Loan

One advantage of share secured loans is that they may be easier to qualify for compared with other types of personal loans.

Having your savings act as collateral means that you assume all the risk. “If you don’t repay the loan, the lender may use all or part of the collateral to make up for the loss,” says Pendergast.

Depending on bank or credit union requirements, approval for a share secured loan may be swift. You apply for the loan, and then the lender verifies your savings and approves your loan application.

Unlike other types of loans, a share secured loan doesn’t require scrutiny of your credit rating for approval. 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.

That’s not to say that your credit score doesn’t matter for a share secured loan. Your credit history can still affect the interest rate you pay to borrow.

Savings Secured Loan Terms

Typically, credit unions or banks set the loan rate based on the interest rate for your savings account, adding 1% to 3% on top of that. If you’re getting 1% interest on a CD, for example, you might only pay 2% to 4% on a share-secured loan. At Navy Federal, for instance, savings secured loans are offered at the share rate plus 2% for terms up to 60 months, and share rate plus 3% for 61-180 months; certificate secured loans are available at the certificate rate plus 2% for up to 60 months.

And unlike a credit card, which has a variable interest rate, a share secured loan usually has a fixed rate. That means your rate won’t increase over time, giving you predictability with payments and protection if interest rates rise after you take out the loan.

Additionally, the time you have to repay a share secured loan can vary by lender. Lenders commonly provide five to 15 years to repay a savings secured loan.

Stretching out the loan term can make repaying a larger share secured loan easier because it may lower your monthly payment. Just keep in mind that the longer the loan term, the more you’ll pay in interest over the life of the loan.

The upside is that your savings continues to earn interest while you’re repaying the loan, says Pendergast. Any dividends you earn can help offset the interest costs. Of course, because your loan’s interest rate is typically 1% to 3% higher than your deposit account’s earning rate, you will always pay more in interest than you will earn. But if you use the funds to pay off higher-interest debt, you could still come out ahead.

[Read: Best Debt Consolidation Loans.]

Credit-Building Loan Alternatives

Share and savings secured loans are not your only options for building credit and meeting short-term financial needs.

Credit-Builder Loans

Credit-builder loans, offered by banks, credit unions and online lenders, involve the lender holding the amount you’ve borrowed in a bank account while you make payments to build credit. You receive the money once the loan is paid in full.

It’s kind of like a share secured loan, only you don’t have to tie up your savings as collateral. And instead of accessing funds at the beginning of the loan, you get them at the end. Think of it as a structured savings plan that can help you improve your credit history.

However, credit-builder loans may not allow you to borrow as much as a share secured loan, as they usually range between $500 and $1,500.

Personal Loans

There are both secured and unsecured personal loans available for people who don’t have the best credit. With a secured personal loan, you will still have to offer the lender some type of collateral, although it doesn’t necessarily need to be cash savings. For example, you might be able to secure a loan with a car title, a piece of property you own or an investment.

Secured loans may offer lower interest rates than unsecured ones because you’re reducing risk for the lender, but as with a share secured loan, you risk losing your collateral if you default.

An unsecured loan eliminates that risk, but expect a higher interest rate to offset the higher risk to the lender. If you can find a co-signer, however, you should be able to qualify for a better rate, says Sullivan.

[Read: Best Personal Loans.]

Credit Cards

There are also a number of credit card products designed for people with thin or poor credit files. “Some people can go out and get a store card or a gasoline card without a whole lot of trouble,” says Sullivan. “That may be a better way to build credit for some because you’re not tying up your savings.”

If that doesn’t work, you can try for a secured credit card, which generally requires a cash deposit. Aside from the deposit, these cards work the same as unsecured cards, with some even allowing you to earn rewards on purchases.

Ultimately, borrowing from and paying interest on your own money with a savings secured loan really only makes sense if your goal is to build or rebuild your credit. “For people with poor credit,” says Sullivan, “these loans can be a valuable strategy.”

More from U.S. News

What Happens If You Default on a Loan?

Which Personal Loan Lenders Accept Co-Signers?

How Do Peer-to-Peer Loans Work? The Complete Guide

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

Update 12/14/21:

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