Key learning points
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Passbook loans are secured loans that use the balance of your savings account as collateral.
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These loans can be a convenient way to borrow money while rebuilding your credit, as some lenders report repayment activity to credit bureaus.
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There are risks associated with passbook loans, such as limited access to your savings until the loan is repaid and having to pay interest on your own money.
Also called an equity or savings-backed loan, passbook loans allow you to borrow against your own savings. Your savings account functions similarly to a secured personal loan and acts as collateral, meaning that if you default on the balance, your savings can be seized to repay the overdue balance.
If you don’t have the best credit score and are having trouble getting approved for a traditional personal loan, you may be able to get the money you need through a passbook loan, which often offers lower rates than bad credit loans.
While passbook loans are useful for building credit and can help you avoid dipping into your savings, they are a relatively rare borrowing option and – like any secured (or bad credit) loan – come with risks. First, you risk losing your earned savings if you are unable to pay back the full balance. Additionally, you won’t have access to your savings until the loan is repaid, so if an emergency arises, you’ll have to withdraw the money from your checking account or take on more debt.
What is a passbook loan?
Passbook loans are secured loans that use the balance of your savings account as collateral. To qualify, you need a savings account or a certificate of deposit (CD). Unlike traditional loans, passbook loans are easier to obtain from most lenders because of your collateral. Although rare, these loans are offered by financial institutions, such as banks and credit unions, and can be a convenient way to borrow money while rebuilding your credit.
Some lenders allow you to borrow some or all of your existing savings, but most allow loan amounts of 90 to 100 percent of their account amount. However, this is not a requirement. Individuals can borrow as little or as much as they need.
Please note that lenders may report your repayment activity and loan information to the credit bureaus. Since repayment history makes up the majority of your FICO and VantageScore, you need to consider your ability to make consistent payments from inception to full repayment. If the lender reports your activity and you often pay late or not at all, your score will drop even further, making it difficult to get approved for any type of loan or loan product in the future.
Bank interest tip
Make consistent, timely payments on the loan to improve your credit, especially if the lender reports your passbook loan to the credit bureaus.
How does a passbook loan work?
Some institutions may require that you have an existing CD or savings account with them to qualify for a passbook loan. Before you apply, read the terms and agreements page to make sure you don’t apply (and then take a credit hit due to a hard check) only to be rejected.
Because your money is used to finance the loan, you will not have access to your savings or CD account during the repayment period.
Your lender will place a savings account on the loan amount and you will not have access to the loan amount until it is repaid. Passbook loans are repaid in regular, monthly installments (payments), just like other lending options. As you make these loan payments, the bank will release the same amount from your retained savings.
By the time you have repaid your loan in full, you will regain access to 100 percent of your savings collateral. While this can be inconvenient, the money in the account continues to earn interest at the standard annual rate of return, so you can end up with more money in the account than when you started.
Should you get a passbook loan?
It may seem redundant to borrow from your existing savings instead of just tapping into the money you already have, but there are times when using a passbook is the ideal financing option. First, passbook loans provide a unique way to grow your credit score through positive repayment habits. These loans can also provide psychological cushioning. Some may find it stressful if their savings run out quickly, and others may worry about their ability to replenish the account. In this case, passbook loans still use the money already in the borrower’s account, but the money is withdrawn at a slower pace.
If you have strong credit and an existing repayment history, borrowing with your own money unnecessarily places the financial risk on you rather than the financial institution. Most lenders approve individuals with good credit and offer the most competitive rates to borrowers with excellent credit. If you fit into this (or a similar) financial category, consider looking into 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?
There are a handful of benefits that passbook loans can provide, but these aren’t ideal for every borrower or situation. Before making a decision, consider both the short- and long-term effects of borrowing with your own money to determine whether a passbook loan is best for you.
Plus points
- Lower interest rates. Interest rates on passbook loans can be as low as 2 percent APR, compared to the average unsecured personal loan rate of 10.73%.
- Minimum requirements. Because taking out a loan with a savings account serves as collateral, the credit requirements and approval are less strict.
- Helps rebuild credit. Making consistent, on-time payments over the life of the loan can boost your credit score. However, if this is your main reason for taking out a passbook loan, ask if the lender reports payment activity to the credit bureaus.
- Earns savings interest. The part of your savings that is held at the bank still earns interest. This can slightly reduce the overall cost of borrowing a passbook.
Cons
- Your credit may not improve. 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. Additionally, your credit will take a hit if you make late payments on your passbook loan.
- No safety net in case of emergency. If unexpected costs arise and you have to pay them, you run the risk of not being able to pay off the passbook loan. Even if you are not at risk of defaulting on the loan, you will not have access to your entire savings fund. If this is your only one emergency fund and a crisis occurs, you may take on more debt to cover costs.
- You pay to borrow your own money. Ultimately, whatever loan amount you’re approved for means the money is already in your savings account. You pay the bank for permission to use your own money.
it comes down to
Passbook loans may seem like an attractive option at first glance, but proceed with caution. Because the loan is (partially) covered by your savings balance, you have limited access to your savings until the borrowed money has been repaid. Additionally, you are responsible for paying interest on your own money, and late payments can negatively affect your credit score.
Ultimately, borrowers who feel confident in their ability to comfortably make their monthly payments and want to grow their credit score should turn to a passbook loan. Borrowers with good credit and an existing credit history may do better if they use a traditional unsecured loan to minimize risk and keep their savings accessible.
