Taking out a $3,000 loan while $3,000 sits in your savings account sounds backwards. In a few situations it is the cheaper move, and the savings mainly serve to get you approved.
A share-secured loan (credit unions call deposits “shares,” so the name follows) lets you borrow against money sitting in your own account. Banks offer the same idea as a savings-secured or CD-secured loan. The money stays in the account, frozen, and you repay the loan in monthly installments like any other installment loan.
Why is a share-secured loan easier to get?
Secured lending is generally the part of the business where a weak credit file matters least. An unsecured lender is betting on your history and income, whereas here the collateral is cash the lender already holds.
A thin credit file, a past collection account, or a short work history can still matter, since each institution sets its own rules. But the risk to the lender is small, so approval standards are usually looser and the rate is usually lower than what the same borrower would see on an unsecured personal loan. Approval is still not automatic.
How the loan and the hold work
You pick an amount up to the balance you have on deposit, or a percentage of it. Some credit unions lend up to the full balance; others cap it lower. The lender places a hold on that amount, which means you cannot withdraw it while the loan is open.
The frozen money keeps earning its normal dividend or interest. That detail is easy to miss, and it is the reason these loans are cheaper than they first appear.
The loan rate is usually set a few percentage points above the rate the account pays. A credit union might describe it as “your share rate plus 2 or 3 percent,” for example, though the margin varies by institution, so check the current terms before you apply. CD-secured loans work the same way, pegged to the CD’s rate.
As you pay down the balance, some lenders release a matching slice of your savings. Others keep the whole amount frozen until the final payment. Ask which method yours uses, because it affects how fast you get access back.
Where it makes sense
This is a narrow product. It does a few jobs well and most other jobs poorly.
The credit-building case is the most common one. The Consumer Financial Protection Bureau lists secured cards and credit builder loans among its ways to start or rebuild credit history, and a savings-secured loan works on the same principle. Many credit unions report these loans to the credit bureaus (the companies that compile credit reports) as installment loans. A year of on-time payments adds positive history, and for someone with a thin file that can matter a lot. Confirm the lender reports to all three major bureaus before you sign, since a loan that is never reported does nothing for your score.
The CD case is about penalties. Breaking a CD before it matures usually costs a set amount of interest, often a few months’ worth depending on the term. If you need money for a short stretch and the CD matures soon, a loan against it may cost less than the penalty. Do the arithmetic both ways.
There is also a habit argument. Some people find it easier to rebuild savings by making a fixed loan payment than by promising themselves to put money back later.
What $3,000 actually costs to borrow
People miscount this in both directions: some assume the loan costs nothing because “it’s my own money,” and others count the full interest as pure loss.
Here is how it works out on $3,000 in savings earning 2 percent a year. Suppose the credit union offers a share-secured loan at 5 percent, three points above the savings rate. You borrow $3,000 for 12 months and the lender keeps the full $3,000 frozen until the loan is paid off.
Whether that is expensive depends on what you would otherwise do. If the alternative is withdrawing the $3,000 and spending it, you would give up the $60 of interest and pay no loan interest. By borrowing instead, you pay $81.87 and still collect roughly $60. The true extra cost of borrowing is about $22 for the year.
If the alternative is not spending the money at all, the full $81.87 is the cost, since you would have earned the $60 anyway. And if your lender releases savings as you pay, you earn a bit less than $60 while regaining access sooner, which moves the net cost up slightly.
Two smaller details. Savings interest is taxable income, while interest on a personal loan like this one is personal interest, which the IRS says in Topic 505 is not deductible. For small amounts the effect is minor, but it tilts the math a little against the loan. Also check for any origination fee, which would add to the cost.
Where it can go wrong
If you stop paying, the lender takes the pledged savings to cover the balance. You lose the money, and the late payments and default can still show up on your credit report. A loan meant to build credit can end up hurting it.
A less obvious risk is that frozen money is not an emergency fund. If your car breaks down in month four, you cannot touch the pledged savings. People sometimes pledge their only cushion to build credit, then turn to a credit card at a far higher rate when trouble hits. Keep at least some separate cash unpledged before doing this.
Then there is opportunity cost. The pledged amount earns a savings rate while you pay a higher loan rate. For a year of credit building on a small balance, the spread is modest. Over several years on a large balance, it adds up.
Is it better than a secured card or a credit builder loan?
A share-secured loan is one of three common starter products. A secured credit card asks for a cash deposit that becomes your credit limit. A credit builder loan works in reverse: the lender puts the loan amount in a locked account, you make payments, and you receive the money at the end.
Scoring models look at both installment and revolving accounts, and a mix of both is one of the factors they weigh. Someone with only a secured card might benefit from adding an installment loan, and the reverse is also true. The credit builder loan fits people with no savings at all, and the share-secured loan suits someone who already has savings to leave untouched for a while.
The card also gives you a line you can reuse, and it rewards keeping the balance low relative to the limit. The loans give you a fixed payment and a fixed end date, which some people find easier to manage.
Getting one from a credit union
- Open a membership and a savings account if you do not have one. Most credit unions require a small minimum deposit to join.
- Ask for the share-secured or certificate-secured loan terms: the rate, how it is set relative to your savings rate, the minimum and maximum amounts, and any fees.
- Confirm that the loan is reported to Equifax, Experian and TransUnion. If building credit is the goal, this is the question that matters most.
- Ask whether pledged funds are released as you pay or only at payoff.
- Choose an amount and term you can repay without strain. For credit building, a small loan over 6 to 12 months is often enough.
- Set up automatic payments from a different account so a missed payment never happens by accident.
When the loan is paid off, the hold comes off and the savings is yours again, with the interest it earned along the way. You also have a year of on-time payments on your record, and a closed account paid as agreed generally stays on your credit report for years.
Related reading
- The Best Credit Builder Loans in the U.S.
- Secured Credit Cards You Can Get Without an SSN
- How Long Does It Take to Build Credit?
None of this is financial advice. Rates, holds and credit reporting differ by credit union, so get the terms in writing before you pledge your savings.
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