In a cash-secured loan, you use your own funds as collateral to borrow money. Your savings secures the loan, just as your house backs up your mortgage. Typically, such a loan requires you to keep your money in a savings account or a certificate of deposit until the borrowed funds are paid back. Because you borrow from the same financial institution that holds you savings, the bank doesn't assume any risk.
How the Loans Work
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After depositing your money, you apply for a loan against the balance. Depending on the financial institution, a cash-secured loan may be available as a lump-sum loan, a line of credit, or a credit card.
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You can't withdraw the cash that secures the loan, and you can't use it to make your loan payments. However, you normally continue to receive interest on the deposited amount.
Amounts and Duration
Some banks let your borrow against a $50 deposit, while others require a minimum of $3,000 for a cash-secured loan, according to Nolo. Loan amounts can go as high as $50,000, Bankrate reports, but secured credit cards often are available with a $300 deposit. Some institutions allow you to borrow only half of your balance, but others allow 100 percent.
The payback period typically runs between one and five years. Some loans require regular installment payments, while others are flexible, even allowing you to repay everything at the end.
Advantages for Borrowers
If you have a short credit history or a poor credit score, cash-secured loans can help you build positive credit. They also enable you to borrow despite weak credit. For example, by borrowing against a CD instead of making an early withdrawal, you can avoid paying a penalty.
Approval for a cash-secured loan typically is a quick process. You may get access to the money as soon as the next day. You then can use the money as you choose -- to take a vacation, make home improvements or expand your business, for example.
The interest rate on a cash-secured loan usually is lower than other loans. Once you've paid back the balance, you'll have your savings intact.
Cash-Secured Loans for Improving Credit
Not all banks report cash-secured loans to the major credit bureaus. If your goal is to boost credit:
- Choose a bank that reports secured loans and credit cards to the major credit bureaus.
- If you get a secured credit card, ask whether or not the bank reports it as secured. If it does, the card may not help your credit much.
- Always make your payments on time.
- For the best boost to your credit, charge at least something every month on your secured credit card. Then pay off the entire balance each month. This proves to the bank that you use credit responsibly and aren't charging more than you can afford to pay.
Potential Risks
Not all cash-secured loans are good deals. Shop around, because interest rates vary. A typical rate is 3 percent more than your savings account pays, according to Bankrate.
Secured credit cards charge higher interest and fees than other credit cards. Although the amount varies, there's usually an annual fee. Some also require an application fee.