What is a secured equity loan and how does it work?

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Shared secured loans are loans that use your savings balance, instead of your credit score, to back up the loan. They are a good opportunity to rebuild your credit because even if you have a bad credit history, you have a good chance of qualifying. Building good credit will make it easier for you to reach your financial goals, whether it’s buying a car, buying a house, or opening a credit card.

What are secured equity loans?

A secured equity loan uses the assets of an equity account, also known as a savings account, to back up the loan. Banks and credit unions offer savings-backed loans, which can also be referred to as “passbook loans”.

When you take out equity-backed loans, the equivalent assets in your savings account are frozen and become available again as you repay the loan. The maximum amount you are allowed to borrow varies from bank to bank. Some lenders may allow you to borrow the full amount from your savings account or a percentage. The money is repaid in monthly installments which are generally spread over five to 15 years.

Because they pose little risk to lenders, equity-backed loans typically come with low, fixed interest rates, often 1 to 3% above the dividend or the interest rate paid on the account by. the bank.

How Do Shared Secured Loans Work?

An equity loan is guaranteed by your savings account, your securities account or your monetary account. When you are approved for a secured equity loan, your lender will suspend the amount of savings you are borrowing from.

You can repay the loan through monthly automatic withdrawals, direct deposits, or monthly checks. If you don’t repay the loan, the savings your lender has as collateral will usually be used to cover the loan.

Although your savings are used to support the loan, you should avoid making late payments or defaulting. This can cost you penalties or late fees and hurt your credit history, as secured equity loans get reported to the credit bureaus.

If building credit is your goal when looking for a secured share loan, consider taking out a small amount that is easier to repay quickly.

Who are secured equity loans best for?

Secured equity loans are designed primarily for those looking to build or rebuild credit. If the loan is reported to the credit bureaus, making monthly payments on time can help improve your credit profile.

Additionally, for consumers with less than stellar credit, this type of loan may be easier to qualify than a traditional personal loan.

“The credit institution knows that the borrower has collateral on his savings account. Thus, the bank takes very few risks, ”explains Daniel Milan, Managing Partner of Cornerstone Financial Services.

Be pre-qualified

Answer a few questions to find out which personal loans you are prequalified for. The process is quick and easy, and it won’t affect your credit score.

Why Use Secured Equity Loans?

There are a number of reasons to use secured equity loans instead of withdrawing money from your savings account:

  • Build credit. If you have bad credit or no credit, these loans can help you develop your credit. Anytime you make loan payments or pay off a loan, it will be reported to the credit reporting agencies, and your credit score should improve. Have your lender report loan payments to the credit bureaus and verify that they have done so by checking your credit report. Each year, you can request a free credit report from each of the major credit bureaus: TransUnion, Equifax, and Experian.
  • Save on future loans. While secured equity loans may cost you money in interest payments now, a higher credit score should save you money through lower interest rates on mortgage loans. the future.
  • Use for any purpose. Unlike some types of loans like auto loans related to cars, you can use shared secured loans for various things. The general rule, however, is that you should only use them to pay for something you really need and can’t afford up front.
  • Protect savings. If you’re struggling to stay disciplined when building up your savings, shared secured loans may be right for you. The loan encourages you to replenish your savings by repaying your loan. This way, at the end of the loan term, you will have cash reserves that you can rely on if you need them again.

While using your savings account as collateral may seem riskier than taking out an unsecured loan, shared secured loans offer real opportunities to rebuild credit and improve your financial future. If you opt for an unsecured loan instead, compare the rates online before you apply.

You can get an idea of ​​how much you will pay each month by using a loan calculator.

What to watch out for

If you are considering a secured equity loan, keep in mind that there are some potential drawbacks or risks associated with this type of loan.

For example, the savings you use as collateral will be frozen until you pay off the loan in full, so you won’t have access to the funds. If you don’t repay the loan, your savings account will likely be used by the bank to pay off the installment loan balance, Milan said. “It could wipe out your household’s rainy day fund. “

As with any type of loan or credit application, be sure to read the fine print and review all of the terms of the agreement before signing. Make sure you understand the true cost of the loan, including upfront fees or annual fees, to ensure that you can make loan repayments on time and avoid defaults.

“Make sure the payment is within your budget,” says Katie Bossler of GreenPath Financial Wellness. “The number one factor in a credit score is paying bills on time, so if the purpose of the loan is to create credit, it is important for the consumer to ensure that the monthly payment fits into the bill. budget and can be paid on time. each month.”

How to qualify for a secured equity loan

Because you mostly borrow from yourself, qualifying for a secured equity loan is usually a straightforward process. The assets in your savings or CD account will be used as collateral for the loan.

While your credit rating is not an approval factor, it could affect the interest rate you pay on the loan. The higher your credit score, the lower your interest rate can be.

Terms and conditions

The terms and conditions of secured equity loans vary from lender to lender. Many lenders allow you to borrow up to 100% of your savings or CD balance, while others allow you to borrow a percentage of what you have deposited.

Interest will be charged on the borrowed money. Typically, the rate is based on the interest or dividend paid by the lender on your savings account or CD account plus 1-3%. For example, if your savings account has an APY of 1%, you can pay 2-4% interest.

The repayment term for a secured equity loan also varies depending on the lender and the amount borrowed, but it is generally five to 15 years.

Be pre-qualified

Answer a few questions to find out which personal loans you are prequalified for. The process is quick and easy, and it won’t affect your credit score.

Alternatives to Secured Loan Sharing

If you are looking to meet short term financial goals or improve your credit score, there are other options available besides shared secured loans.

Similar to a secured equity loan, a secured credit card is attached to a deposit account. The credit limit is the same amount deposited into the account. If you do not make the agreed payments, the money is withdrawn from the account.

A credit loan also works like a secured equity loan, but you pay off the loan before you can access the money. The lender you choose will deposit the funds into a savings account. When the loan is paid off, you will have access to the money. This makes the homebuilder loan better suited to long term needs.

A secured personal loan is backed by an asset you already own, such as a car, boat or motorhome. If you default on the personal loan, the lender can foreclose on your property to recoup its losses.

Next steps

A secured equity loan can be a good option to consider if you are looking to build or rebuild credit. Although there is a cost to taking out this type of loan, it can be a good idea if your goal is to potentially obtain other types of credit that are more difficult to obtain, such as a mortgage.

Just make sure that when using this type of loan you understand all of the terms and conditions and check with your lender to confirm that the loan will be reported to the credit bureaus.

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