When it comes to borrowing money, there are a variety of loans available. You’re probably familiar with most options – from car loans and home mortgages to credit cards and student loans. But have you ever heard of a share-secured loan? If you answered no, you’re not alone.
Share-secured loans aren’t the most common type of loan today. Often overlooked, these loans provide unique benefits that can unleash a slew of fiscal perks if used correctly – including being one of the most affordable financing options available.
Before jumping into the key features of this loan, it’s helpful to distinguish what “secured” means and how it can impact you financially.
Secured vs. Unsecured Loans:
There are two types of loans: secured and unsecured.
- Secured Loans:
A loan is considered “secured” if it is backed by some form of collateral. For example, car loans and home mortgages are secured loans. If you cannot repay your loan, the lender can take ownership of the collateral (your car or home) to recoup their losses.
Because secured loans are lower risk for lenders, it’s generally easier to become approved for this type of loan, and the interest rates are cheaper.
- Unsecured Loans:
In contrast, unsecured loans do not have any collateral. Credit cards and personal loans are common examples. Without any form of collateral, lenders assume greater risk when granting unsecured loans. As a result, the interest rates are typically higher, and it can be more difficult to become approved, depending on your credit history.
Luckily, share-secured loans are secured – meaning you’ll benefit from lower interest rates and easier approvals.
Characteristics of Share-Secured Loans:
A share-secured loan functions very similarly to a personal loan. You receive a specific amount of money upfront from the lender. Then, you make monthly payments toward the outstanding balance until the loan is repaid in full.
- Collateral: Instead of securing your loan with an asset, such as a car or home, your own money is used as collateral. These funds can be from your savings account or an existing share certificate account (commonly called a certificate of deposit).
If you cannot repay the loan, the lender will use your savings to cover the loss.
- Pricing: Because your own money is used to secure the loan, the interest rates are typically very generous. Usually, you’ll see rates presented as: Current savings rate + 4% APR.
For example, if the money in your savings account currently earns 0.50% APY, in this example, your share-secured loan rate would be: 0.50% + 3% = 3.5% APR.
The pricing structure of these loans makes them one of the most affordable options available.
- Loan Terms: Most share-secured loans are shorter-term, often between six months and a year. But most lenders will grant longer terms, for example, up to 60 months.
- Approvals: Since you’re using your own money as collateral, share-secured loans present practically no risk for the lender. Consequently, they are one of the easiest loans to get approved for – even if you don’t have great credit.
How Share-Secured Loans Work:
The best way to illustrate how these financial tools work is through an example.
|Loan Amount||Interest Rate||Term||Monthly Payment||Total Interest Paid|
|$1,500||3.5% APR||12 Months||$127.38||$28.59|
Assume you want to borrow $1,500 to purchase a new appliance for your home. Your lender will give you $1,500 upfront to use for your purchase. Then, a freeze will be placed on $1,500 in your savings account (or the funds you designate). You will not be able to access or use these funds.
Each time you make a monthly payment of $127.38, the principal portion of the payment unlocks your frozen funds. Meaning you can access some of the money in your savings again.
Once the loan is repaid in full, your entire $1,500 will be unfrozen, and you will have only paid $28.59 in interest over the 12-month term. It’s an extremely affordable option when compared to credit cards.
Common Uses for Share-Secured Loans:
One of the main reasons that share-secured loans aren’t super popular is that they can be a bit confusing. After all, why even bother with a loan if you have money in your savings?
In addition to being extremely affordable and one of the easiest loans to become approved for, they are also quite versatile. Consider the following scenarios:
- Replenish Savings: When you pull money from your savings for a large purchase, how quickly do you return the money used to your account? While you might have the best intentions, life happens. And those funds might not be replenished in a timely manner.
A share-secured loan forces you to return your savings balance to the original amount. So, once the loan is repaid, it’s like your savings account was never impacted.
- Psychological: Imagine you worked very hard to save up $2,000 in your savings account. Suddenly, you have an unexpected expense of $1,500. It can be disheartening to watch all your savings progress be erased instantly by pulling money from your account.
Instead, a share-secured loan keeps your savings intact so you can resume your forward progress once the balance is repaid.
- Credit Rebuilding: The most common use for a share-secured loan is to build or rebuild credit scores. Imagine you take out a loan for $500 at 3.5% APR for 12 months. Instead of spending the money, you put it aside in your savings.
Then, each month you make the required monthly payment. It should be easy since you already have the money set aside. Each time you make an on-time payment, the lender reports it to the credit bureaus – helping to boost your score.
After a year, you’ll have 12 on-time payments added to your credit history, and it would only have cost you $9.53 in interest. That’s a small amount to pay for a jump that could save you hundreds on your next car loan!
- First-Time Loan: Like the credit rebuilding strategy, many parents have their young adult children open share secured loans to teach money management. Before buying their first car or getting a credit card, a share-secure loan is a great way to introduce them to handling loan payments responsibly. And it will help them start building their credit score at the same time.
We’re Here to Help!
As your credit union, we aim to help you make the best financial decisions. That includes introducing you to beneficial financing options you might have yet to consider.
If you’re interested in learning more about share-secured loans or how they could work in your favor, we’re ready to help. Please stop by any of our convenient branch locations or call 888-777-9982 to speak with a lending team member today.
Each individual’s financial situation is unique and readers are encouraged to contact the Credit Union when seeking financial advice on the products and services discussed. This article is for educational purposes only; the authors assume no legal responsibility for the completeness or accuracy of the contents.