Providing collateral for a loan means guaranteeing the return of the money that has been lent to you by providing an asset as security.
Typically, when you apply for a loan, you offer your personal guarantee to cover the repayment of the loan, in other words, you guarantee it with all your assets, present or future. In some cases, the bank or the lender may ask you for an additional guarantee in order to release the money: the security of an asset as collateral. This involves leaving one or more physical or financial assets as a guarantee that you will fulfil your obligation: a vehicle, a bank deposit, shares… You can do this yourself, as the recipient of the loan, or through a third party, who, instead of acting as guarantor, pledges an asset of their own, thus limiting the risk.
You may have heard of something called a “pledge loan” and wondered – what exactly does that mean? A pledge loan is a unique type of financing option that allows borrowers to use existing savings or investments as collateral for a new loan.
In this comprehensive guide, we’ll explain what pledge loans are how they work their pros and cons, and whether a pledge loan is right for your financial situation.
What is a Pledge Loan?
A pledge loan, sometimes called a passbook loan or savings secured loan, is a loan that is secured or backed using funds you have in an existing savings account, certificate of deposit (CD), or other liquid asset account You pledge those funds as collateral for the new loan you take out
Here is a quick overview of how it works:
- You have an existing savings account, CD, or other funds
- You take out a new personal loan from the same institution
- You pledge or assign your existing funds as collateral for the new loan
- The lender places a hold or lien on your pledged funds/account
- If you default, the lender can seize your pledged assets to repay the loan
So in essence, you are borrowing against yourself – using your own savings as the security for the loan.
How Do Pledge Loans Work?
When you get a pledge loan. the basic process typically works as follows
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You apply for the pledge loan through your existing bank, credit union, or other financial institution where you already have savings funds, a CD, or other eligible assets.
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The lender reviews your application and determines the loan terms, which may include an attractive low interest rate since your funds serve as the collateral.
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You keep full access to the pledged funds and keep earning interest/dividends, but the lender places a hold or lien on the account.
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As you repay the pledge loan per the repayment schedule, the hold on your account gradually decreases.
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If you default on the loan, the lender has the right to seize enough of your pledged funds to repay the outstanding loan balance.
Throughout the life of the loan, you make payments via automatic bank transfers, mail, online, etc. The lender reports your payment history to the credit bureaus, helping build your credit.
What Assets Can Be Pledged?
Common accounts accepted for pledge loans include:
- Savings accounts
- High-yield savings accounts
- Money market accounts
- Certificates of deposit (CDs)
- Cash management accounts
Some lenders may also accept pledges of brokerage accounts, stocks, bonds, or other securities. Most do not allow retirement accounts like IRAs or 401(k)s to be pledged for a loan.
What Are the Benefits of Pledge Loans?
There are several potential benefits that make pledge loans appealing financing options, including:
Lower Rates – By securing the loan with your savings, you may qualify for lower interest rates than unsecured alternatives like credit cards or personal loans. This reduces the total interest cost over the loan repayment period.
Access Savings – You maintain access to the money in your pledged account and keep earning interest or dividends. The hold prevents withdrawals, but you aren’t actually surrendering the funds.
Build Credit – On-time loan payments are reported to credit bureaus, enabling you to establish or strengthen your credit history. This can help improve your credit scores over time.
Fast Funding – Because the loan is secured at the outset, funding can often be quick after a short application process. No long credit check or underwriting is required.
Flexible Terms – Loan repayment terms are often flexible, with options like paying interest-only for a while as you get started repaying the principal balance.
Retain Assets – Your savings or CD remain yours throughout the loan term and after it’s been repaid. You don’t have to liquidate or surrender the assets.
What Are the Downsides of Pledge Loans?
However, there are also some potential disadvantages to weigh:
Higher Rates Than Assets Earn – The loan interest rate is usually 1-3% higher than the interest your savings or CD earns. So you lose a bit of the earning potential.
Risk of Default – Like any loan, defaulting has serious repercussions – you could lose your pledged savings that are seized to repay the loan.
Limits Access to Savings – You can’t withdraw or close the pledged account until the loan is satisfied without defaulting on the loan. This reduces flexibility.
Variable Rates – Pledge loans may have variable interest rates that could rise over time, increasing your repayment costs.
Tax Implications – Any savings account or CD interest/dividends are taxable income. Withdrawing pledged funds to pay taxes could trigger default.
Credit Impact – Defaulting on a pledge loan damages your credit history. And having a loan secured by assets can negatively impact ability to get additional credit.
Is a Pledge Loan Right for You?
Whether a pledge loan makes sense depends on your unique financial situation and needs. It’s smart to consider these key factors:
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Do you have adequate liquid savings to pledge? You’ll need enough to provide sufficient collateral.
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How much do you need to borrow? Pledge loans often have lower limits than other types.
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What will the funds be used for? What type of repayment term aligns with your usage?
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How urgent is your need? Pledge loans can provide quicker access to financing than alternatives.
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How strong is your credit history? Those with poor credit tend to benefit most from pledge loans.
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What rates and terms can you qualify for with other loan/financing options?
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Are you comfortable locking up access to your savings for the loan term?
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Are you confident you can repay the loan and avoid default?
Alternatives to Pledge Loans
Pledge loans aren’t right for everyone. Some other options to get fast financing include:
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Personal loans – Unsecured loans with no collateral requirement. Higher rates but with predictable fixed payments.
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Credit cards – Revolving credit lines allow flexible borrowing and repayment, but variable interest rates.
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Payday alternative loans – Small short-term loans through credit unions as lower-cost options to payday lenders.
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401(k) or IRA loans – Allows borrowing against retirement savings. Must be repaid in 5 years or converted to withdrawal.
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Home equity loan/line – Secured by home value and offers attractive rates, but closing costs and risk of foreclosure.
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Auto title loans – Similar to pledge loans, but uses car title as collateral. Higher fees and default risks, but quick access to cash.
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Pawning valuables – Lends money against items like jewelry. Avoid risks of losing collateral if unpaid.
The Bottom Line
Pledge loans can be an affordable, fast, and easy way to tap funds in an existing savings or CD account while retaining ownership. Just be sure to carefully weigh the pros and cons for your situation before using savings as collateral. Evaluate alternatives to ensure a pledge loan is the best fit before moving forward. With proper use, it can provide financial flexibility in times of need.
Differences to a mortgage
Unlike a mortgage, where you can continue to use the mortgaged property while you are paying for it, by collateralising a loan the collateral security may pass into the hands of the lender, and you may not have the use of it during the life of the loan. However, if it is a financial asset, such as shares or an investment fund, it can still generate a return for you.
Providing collateral for a loan or applying for a mortgage loan?
A collateralised loan instead of a mortgage loan (where payment is guaranteed by the value of the property) is cheaper to arrange, as there is no need to pay costs such as valuation and/or administration fees. In a loan with a collateral guarantee, all you have to do is go to the notary to formalise the agreement in a public deed or in a policy that will be notarised.
Also, by providing a collateral asset as an additional guarantee of payment, you are likely to have access to more capital and/or a more competitive interest rate.
Top 3 Things to Know Before Getting a Pledge Loan With Navy Federal Credit Union
FAQ
What is the point of a pledge loan?
Do you get your money back on a pledge loan?
Do pledge loans help your credit?
What is pledging in a loan?
What is a pledged loan?
Pledged loans are a kind of secured loan that requires the borrower to pledge assets as collateral to secure funding. 1 When you don’t have the money to purchase a vehicle or home outright, as most people don’t, some lenders may offer you a secured loan. Credit cards and personal loans are there when you need to make other important purchases.
How does a pledge loan work?
When the terms are fulfilled and the borrower has repaid the loan in full, the lender will transfer the ownership interest they had in the pledged asset back to the borrower. Some common pledge loan options include pledged asset mortgages and pledged securities using investments.
What is a savings pledge loan?
Just like an unsecured loan, a savings pledge loan requires the borrower to make fixed monthly payments until the end of the loan term which can vary and go up to 144 months. At Hughes Federal Credit Union, secured funds from loans pledged against a savings account become available as the loan balance declines.
What is a pledged asset mortgage?
A pledged asset mortgage allows your assets to earn interest and keep growing while you pay off the loan balance. A pledged asset mortgage tends to work well for high-income borrowers who have already done a fair amount of financial planning. Just like with every other lending product, using pledged assets to secure a loan has its pros and cons.