What is a Cash Secured Loan and How Does it Work?

A cash secured loan is a type of secured loan that is backed by a savings account or certificate of deposit (CD) held at a bank or credit union This unique loan product can help consumers with little or poor credit build or rebuild their credit scores.

Cash secured loans allow borrowers to leverage funds they already have on deposit as collateral for a new loan. The funds in the savings account or CD serve as security for the lender, ensuring repayment if the borrower defaults.

In exchange, borrowers with low credit scores or thin credit files get access to credit they might not otherwise qualify for Cash secured loans provide a way to establish positive payment history and boost credit.

How Do Cash Secured Loans Work?

With a cash secured loan, the borrower pledges funds in a savings account or CD as collateral for the loan. The loan amount is typically limited to 90-100% of the pledged funds.

For example, if you have $5,000 in a savings account, you might be able to get approved for a cash secured loan up to $4,500 or $5,000, using the funds in the account as security.

The savings account or CD serves as collateral, meaning the lender can seize the funds if you stop making payments on the loan. The funds must stay in the account for the duration of the loan term.

Cash secured loans are offered by banks and credit unions. To get one, you’ll open a new savings account or CD at the lending institution and pledge those funds as collateral. Or, you can pledge funds you already have on deposit if approved.

In most cases, the savings account or CD needs to be opened at the same institution that is extending the loan. So you may need to open an account at a new bank or credit union to get approved.

Benefits of Cash Secured Loans

There are several potential benefits that make cash secured loans a smart financing option for some borrowers:

• Improved credit – If payments are reported to the credit bureaus, a cash secured loan can help you build or rebuild credit. Successfully paying off an installment loan adds positive history to your credit reports.

• Lower interest rate – Interest rates on cash secured loans may be lower than unsecured loan options, since your pledged funds reduce the lender’s risk. An established banking relationship can also score you a lower rate.

• Flexible use of funds – Money borrowed with a cash secured loan can be used for any purpose, whether it’s consolidating high-interest debt, financing a home improvement project, or funding a major purchase.

• Fixed payments – Cash secured installment loans come with fixed interest rates and payment amounts, making your monthly budgeting easier.

• Accessible amounts – Cash secured loans are available in relatively low amounts compared to other loan products, making them ideal for credit beginners. Loan amounts of a few thousand dollars are readily accessible.

• Maintain liquid savings – By borrowing against your existing savings, you can avoid draining your funds. This helps ensure you don’t wipe out your emergency cash or other liquid assets.

• Forced savings – Making fixed loan payments can help build financial discipline, and your savings continue growing interest while pledged as collateral. Once the loan is paid off, those savings are still intact.

What Credit Score is Needed?

Cash secured loans are accessible even with poor credit scores and short credit histories. Here are some typical credit requirements:

• Minimum credit score between 500 and 600
• 1-2 years of credit history
• No recent bankruptcies or foreclosures
• Limited delinquencies and collections

Meeting the minimum requirements above does not guarantee approval. But it does mean your application could be considered for a cash secured loan.

Having an existing relationship with the lending bank or credit union can also improve the chances your application is approved. Banking history is evaluated along with your credit reports.

Borrowers with higher credit scores can qualify for lower interest rates on cash secured loans. Excellent credit can potentially drop interest rates below 6-7%, versus double digits for applicants with fair credit.

How Much Can You Borrow?

Cash secured loan amounts are capped based on the collateral funds you have available in your savings account or CD. Typical loan-to-value ratios range from 90% to 100%.

For example, a credit union may extend a cash secured loan up to 95% of your CD balance. So if you have $10,000 in a CD, you could qualify for a $9,500 loan.

Loan amounts can range from a few hundred dollars up to $100,000 or more. But most lenders impose limits of $20,000 or $50,000 for these types of secured loans.

Higher loan amounts are more readily available if you have an existing relationship with the lending institution. Expect lower limits as a new customer with no banking history.

What is a Typical Interest Rate?

Interest rates on cash secured loans will vary based on your creditworthiness and relationship with the lender. Here are some typical rate ranges:

• Excellent credit (720+ score) – 3.99% to 9.99%
• Good credit (680-719 score) – 7.99% to 12.99%
• Average credit (620-679 score) – 11.99% to 18.99%
• Poor credit (below 620) – 15.99% to 24.99%

With excellent credit, rates comparable to other installment loans in the 4-10% range are possible. Expect rates in the 15-25% range with poor credit scores below 600.

An existing banking relationship can help you qualify for discounted interest rates up to 2 percentage points lower than the ranges above. Automatic payment deductions from an account at the lending institution can also score a rate discount.

Always compare interest rates from multiple lenders, as rate ranges can vary by more than 10 percentage points between banks and credit unions.

What Loan Term Lengths Are Available?

Cash secured loan terms are generally shorter than other installment loans, ranging from 12 months up to 5 years (60 months).

Shorter terms of 2-3 years are common, especially for smaller loan amounts. This helps borrowers rebuild credit fairly quickly as they make on-time payments each month.

Some lenders may allow longer terms up to 10 years for larger cash secured loans above $25,000 or $50,000. But most keep terms under 5 years.

Shorter terms often come with lower interest rates as well. Opting for a 2 or 3-year repayment term can potentially drop your rate.

How Do Payments Work?

Cash secured loans feature fixed monthly principal and interest payments, meaning the payment amount does not change.

Your payment will be the same each month until the loan is fully paid off at the end of the term. Payments are made by automatic bank account withdrawals in most cases.

Here is an example payment schedule for a $10,000 cash secured loan with a 4-year repayment term at 8% interest:

• Loan Amount: $10,000
• Interest Rate: 8%
• Term Length: 4 years (48 months)
• Monthly Payment: $235

A portion of each $235 payment goes toward interest charges, while the remainder reduces your loan principal balance. As the principal declines over time, the interest portion gets smaller and more of your payment is applied to principal.

Always use a loan calculator to estimate payments for any loan you are considering based on the loan details. This allows you to budget for the monthly payment amount.

How to Apply for a Cash Secured Loan

Ready to get started with a cash secured loan? Follow these steps:

1. Compare lenders – Research local banks and credit unions that offer cash secured loans and compare interest rates and fees. Credit unions often offer the lowest rates.

2. Open an account – You’ll need to open a new savings account or CD at the lender to serve as collateral, unless you already bank there. Open the account with the amount you wish to borrow.

3. Complete loan application – Apply for the cash secured loan, providing personal and financial information. This includes details on income, existing debts, and credit history.

4. Get approved – The lender will review your credit, collateral account, and banking relationship. If approved, you’ll get a loan offer detailing the rate, fees, and terms.

5. Accept loan terms – Review the loan agreement carefully. If you accept the terms, sign the agreement to finalize the loan. Funds are typically deposited within 1-2 business days.

6. Make payments – Repay the loan each month through automatic withdrawals from your bank account until the balance is paid in full.

Be sure to make all loan payments on time every month. This will ensure your cash secured loan helps build positive credit history.

Pros and Cons of Cash Secured Loans

Cash secured loans offer unique benefits, but also come with some potential drawbacks to consider:

Pros

• Easy to qualify for with poor credit
• Lower interest rates than credit cards or payday loans
• Fixed monthly payments
• Allows savings to keep earning interest
• Forces savings discipline with required payments
• Helps improve credit scores over time