Passbook Loans: Paying To Borrow Your Own Money

Passbook loans, also referred to as savings-secured or savings pledge loans, are a type of secured loan that allows you to borrow from your own savings or CD account. The rates are often lower than bad credit loan rates and repaying one of these loans can help you build credit.

While they do have benefits, passbook loans come with a unique set of risks. Since the loan is backed by your personal savings — also known as collateral — you could lose your savings if you fail to make the monthly payments. Plus, if an emergency arises, you won’t have access to your account until the loan is repaid in full.

What is a passbook loan?

Passbook loans are secured loans that use your savings account balance as collateral. These loans are offered by some banks and credit unions.

Some lenders might allow you to borrow all or a portion of your existing savings, but most allow loan amounts from 90 to 100 percent of their account amount. However, this isn’t a requirement. Individuals can borrow as little or as much as they need.

Passbook loan rates

Some lenders charge all borrowers the same, fixed annual percentage rate (APR) on a passbook loan. Others base your APR on your savings account’s annual percentage yield. For example, let’s say you’re earning an (APY) of 2 percent and lender charges your APY plus 3 percent interest. In total, you’ll be paying an APR of 5 percent on your loan (though your account continues earning its current APY, so the interest is partially offset).

Keep in mind that the rate could be variable, depending on the lender. For example, North Cambridge Co-operative Bank warns that if your account’s APY goes up, your APR will, too. On the other hand, BECU advertises a fixed interest rate.

How do passbook loans work?

Most passbook loans function the same way, regardless of the institution. While the specific terms will vary, here’s how most passbook loans work and what the application and repayment process could look like.

1. Find a loan you qualify for and apply

Some institutions may require that you have an existing CD or savings account with them for passbook loan eligibility. Before applying, read through the terms and agreements page to ensure you don’t apply — and take a subsequent credit hit due to a hard check — just to be denied.

Keep your potential returns as a top consideration when looking for a loan; your savings will continue to accrue interest based on the original APY. To see your actual costs, calculate your returns during the loan term using an APY calculator and compare them with the interest you’ll owe based on our personal loan calculator.

2. Make the payments

Your lender will place a savings account hold on the amount you borrowed, and you won’t have access to the borrowed amount until it’s repaid. Passbook loans are paid back in regular, monthly installments (payments) like other lending options. As you make these payments toward the loan, the bank will release the same amount from your withheld savings funds.

3. Regain access to your savings account

By the time you’ve repaid your loan in whole, you’ll regain access to 100 percent of your savings collateral. While this may be inconvenient, the funds in the account will continue to accrue interest at the standard annual percentage yield, so you could come out with more in the account than when you started.

Should you get a passbook loan?

It may seem redundant to borrow against your existing savings rather than just use the funds already there, but there are times when using a passbook loan is the ideal financing option. For one, passbook loans are a unique way to grow your credit score through positive repayment habits.

On the other hand, if you have strong credit and existing repayment history, borrowing against your own money places unnecessary financial risk on you instead of the financial institution. Most lenders approve individuals with good credit and offer the most competitive rates to borrowers with excellent credit. If you fit one of these financial category, consider looking at low-interest personal loans or a 0% APR credit card before turning to a passbook loan.

What are the pros and cons of borrowing from your savings?

Passbook loans can offer a handful of benefits, but they aren’t ideal for every borrower or situation.

Pros

• Lower interest rates. The interest rates on passbook loans can be as low as 3 percent APR, compared to the average unsecured personal loan rate of 12.57%.
• Minimal requirements. Because taking out a loan with a savings account acts as collateral, credit requirements and approval are less stringent.
• Helps rebuild credit. If you make consistent, on-time payments during the life of the loan, your credit score might get a boost. However, if this is your main reason for taking out a passbook loan, ask whether the lender reports payment activities to the credit bureaus.
• Earns savings interest. The portion of your savings held by the bank still grows interest. This can slightly reduce the overall cost of borrowing a passbook loan.

Cons

• You’re paying to borrow your own money. Ultimately, whatever loan amount you’re approved for means you have those funds already tucked away in your savings account. You’re paying the bank for permission to use your own funds.
• Might not improve your credit. It’s not always a good idea to rely on passbook loans for credit building, as not all lenders report these payments to credit bureaus. Plus, your credit will take a hit if you make late payments on your passbook loan.
• No safety net in an emergency. If an unexpected expense comes up and your emergency fund is tied up as collateral, you risk defaulting on the passbook loan or incurring more debt to cover the costs.

Bottom line

Passbook loans may seem like an attractive option on the surface, but proceed with caution. Because the loan is secured by some or all of your savings balance, you will have limited access to your savings until the money you borrowed has been repaid. In addition, you’ll be responsible for paying interest on your own money, and making late payments can hurt your credit score.

Passbook loans are geared toward borrowers who need a small loan, have an emergency fund elsewhere and are looking to grow their credit. Borrowers with good credit and an existing credit history may fare better using a traditional unsecured loan to minimize risk and to keep their savings accessible.