The Pros and Cons of Share Secured Loans

Share secured loans allow borrowers to use funds in a savings account as collateral for a personal loan. This type of loan can be beneficial for those looking to establish credit or access funds at a low interest rate. However, share secured loans also come with some potential downsides to consider. This article will examine the key pros and cons of share secured loans to help you determine if this type of borrowing is right for your financial situation.

What is a Share Secured Loan?

A share secured loan also known as a savings secured loan or passbook loan, is a loan that uses funds in a savings account as collateral.

Here’s how it works:

• You deposit money into a designated savings account to serve as collateral. This is usually with the financial institution providing the loan.

• The lender places a hold on the amount in your savings account that matches the loan amount.

• You make monthly payments on the loan. As you repay, the hold on your savings account is reduced.

• Once the loan is fully repaid, the lender releases the hold on your savings account so you regain full access to the funds.

• If you default, the lender can seize the money in your savings account to repay the loan.

Share secured loans are offered by banks and credit unions. Loan amounts usually range from $500 to $25,000 with terms from 1 to 5 years.

The Pros of Share Secured Loans

1. Inexpensive

Share secured loans tend to have lower interest rates compared to other types of loans. Rates often start around 3% to 6% APR.

The lender is taking on minimal risk due to your savings account acting as collateral. This allows them to offer a lower rate.

2. Easy Approval

These loans are easier to qualify for than other personal loans or credit products.

Little to no credit history is required in most cases. Approval is based mainly on the funds you have on deposit to secure the loan. Those with poor credit scores can still get approved.

Many lenders provide instant approval decisions. You can quickly access funds without a lengthy application process.

3. Build Credit History

Making on-time payments on a share secured loan can help establish or rebuild your credit profile.

Most lenders report loan payment activity to the major credit bureaus. This allows you to demonstrate responsible use of credit.

With a solid payment history, your credit scores can start to improve over the loan term.

4. Access Your Money

Some lenders allow you to withdraw a portion of the funds in your savings account securing the loan.

As you make loan payments, an equal amount is released from the hold on your savings. This gives you partial access to your money while still using it as collateral.

5. Flexible Use of Funds

Borrowers can use share secured loan funds for a variety of purposes. These loans are not restricted to specific uses like car loans or student loans.

You can use the money for debt consolidation, home improvements, medical bills, vacations, and more based on your financial needs.

The Cons of Share Secured Loans

1. Your Savings Are Frozen

The lender places a hold on the amount in your savings account equal to the loan amount. You cannot withdraw or access those funds until the loan is fully repaid.

For some borrowers, parting with their liquid savings is too high an opportunity cost even if interest rates are low.

2. Risk of Default

If you fail to repay the loan as agreed, you risk the lender seizing the money in your savings account. Defaulting results in loss of your collateral.

This risk is highest if you borrow close to the total amount you have in savings. Be conservative with loan amounts to avoid default.

3. Credit Score Damage

While these loans can help build credit, missed or late payments can damage your credit profile. Payment history is typically reported to the credit bureaus.

Before taking out a share secured loan, make sure you can manage the required monthly payments based on your budget.

4. Missed Investment Opportunities

Tying up your savings in a share secured loan means missing out on interest, investment returns, or other opportunities for that money.

You have to decide if the benefits of the loan outweigh the missed potential gains on your savings.

5. Complex Application Process

Some lenders have a more complex loan application process compared to regular personal loans. You may need to open a savings account and deposit funds before submitting a loan application.

Be prepared for a multi-step process that could take a week or more from start to loan funding.

Who Should Consider a Share Secured Loan?

Share secured loans can make the most sense for certain borrowers:

• Those with little to no credit history who need to establish good payment habits
• People with poor credit scores who cannot qualify for other affordable loan options
• Individuals who need funds for emergencies or bills but want to minimize interest costs
• Borrowers who have substantial savings they are willing to use as collateral for 3-5 years
• People seeking a relatively small loan amount below $10,000

This type of loan provides a way to build credit while avoiding higher rates and fees associated with bad credit loans. If you need to establish or rebuild credit, the pros often outweigh the cons.

Who Should Avoid Share Secured Loans?

There are some situations where share secured loans may not be advisable:

• If you have strong credit, you can likely qualify for cheaper personal loans or credit cards without tying up savings.

• If you have minimal savings, using a large portion as collateral could be risky in case of job loss or income disruption.

• If you need loan funds for longer-term goals like a home purchase. The short terms of share secured loans don’t align with buying a house.

• If you expect to need access to your savings for emergencies or investments in the near future. Freezing funds in a share secured loan would limit your flexibility.

• If you’re unlikely to qualify for better credit in the future, the credit building benefits are diminished.

For borrowers who don’t necessarily need to build credit or who have other good borrowing options, share secured loans are less appealing due to their drawbacks.

Alternatives to Share Secured Loans

Here are a few other options that serve similar purposes:

Secured Credit Card – This also requires a security deposit that becomes your credit limit. Responsible card use builds your score.

Credit Builder Loan – You make payments into a savings account and receive the funds back when the loan is paid off. Helps establish payment history.

Cosigner Loans – A cosigner with good credit may help you qualify and get lower rates on personal loans or other credit products.

Credit Monitoring Services – No loan needed. Join a service to track your reports and scores as you work to improve credit.

The Bottom Line

Share secured loans can be a double-edged sword. The pros include affordable rates, accessible approvals, and potential credit score boosts. However, you have to weigh those benefits against the cons like frozen savings, default risks, and credit damage if you mismanage payments.

Do a personal cost-benefit analysis based on your finances and credit goals. Understand all the lender requirements and fine print before moving forward. With proper research and planning, a share secured loan can be a valuable credit building tool for the right borrower.