Passbook loans: Paying to borrow your own money

If you don’t have the best credit score and are having difficulty getting approved for a traditional personal loan you may get the funds you need through a passbook loan. Passbook loan rates are often lower than bad credit loans. In a nutshell, passbook loans allow you to borrow against your own savings.

While passbook loans are handy for building credit and can help you avoid dipping into your savings, they’re a relatively rare lending option and — like every secured (or bad credit) loan — come with risks. For one, you risk losing your earned savings should you not be able to repay the full balance. Plus, you won’t have access to your savings until the loan is repaid, so if an emergency comes up you’ll need to pull the funds from your checking account or incur more debt.

What is a passbook loan?

Also referred to as a share-secured or savings-secured loan, passbook loans are secured loans that use your savings account balance as collateral. That means if you default on the balance, your savings could be seized to repay the delinquent balance.

You’ll need a savings account or certificate of deposit (CD) to be eligible. Unlike traditional loans, passbook loans are easier to get approved for with most lenders due to your collateral. While rare, these loans are offered by financial institutions, like banks and credit unions, and can be a convenient way to borrow money while rebuilding your credit.

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.

Keep in mind that lenders may report your repayment activity and loan details to the credit bureaus. Given that repayment history is the largest portion of your FICO and VantageScore, consider your ability to make consistent payments from origination to complete repayment. If the lender does report your activity and you often make late payments or miss them altogether, your score will drop even more, making it difficult to get approved for any type of loan or lending product in the future.

How does a passbook loan work?

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. Because your funds are used to back the loan, you can’t access your savings or CD account for the repayment period.

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.

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 present a unique way to grow your credit score through positive repayment habits. These loans can also provide psychological cushioning. Some may find it stressful to see their savings quickly deplete, and others may be concerned about their ability to replenish the account. In this case, passbook loans still use the money already in the borrower’s account, but the funds are taken out at a slower rate.

If you have strong credit and existing repayment history, borrowing against your own money places the financial risk needlessly 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 into this — or a similar — 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?

There are a handful of benefits that passbook loans can offer, but they aren’t ideal for every borrower or situation. Before making up your mind, consider both the short- and long-term effects of borrowing against your own money to determine if a passbook loan is best for you.

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.

At the end of the day, borrowers who are confident in their ability to comfortably make their monthly payments and are looking to grow their credit score should turn to a passbook loan. 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.