I received an interesting offer in the mail from my credit union. It’s for a savings secured loan. The credit union offers to give me a loan if I pledge an equal amount in my savings account as collateral for the loan. If I pledge $10,000, they will lend me $10,000. If I pledge $50,000, they will lend me $50,000.
The loan is a fixed rate loan. For a term up to 5 years, the interest rate would be 2% above the current rate paid on the savings account. The savings account pays 0.8% at this time. So the rate on the loan would be 2.8%.
I will continue to receive interest on my savings, at the same rate the credit union pays to other members. The interest rate on the savings account is of course subject to change by the credit union depending on the market conditions and the competitive environment. They are not going to single me out and give me a low rate only because I have a loan.
I will not be able to withdraw the part of my savings pledged as collateral. As I make payments on the loan and the outstanding loan balance goes down, a corresponding amount of my savings will also be freed up for withdrawals.
That’s the deal. Is it a good one or not? If you need money for something, would you take it?
Borrowing and Keeping Cash At the Same Time
At a first glance it would seem strange to simultaneously borrow money at a higher interest rate and keep cash earning a lower rate. If you think about it for a minute, you know it happens all the time. Anybody having a mortgage at 3% surely has some money in a savings account earning less than 1%.
That’s for liquidity. If you have an emergency, you can spend your reserve. However, with a savings secured loan, your pledged collateral is frozen. If you have an emergency, you can’t use your savings anyway.
So, instead of getting a savings secured loan, why not just spend the money in your savings account on whatever it is you need the loan for — pay off higher rate debt, home improvement, education, etc.?
Raise Credit Score
The letter from the credit union mentions building credit as a benefit for the savings secured loan. It’s true. The loan and your timely repayments will show up on your credit report. It can help raise your credit score.
Rebuild Savings
With a savings secured loan, the bank sets a repayment schedule and automatically deducts the monthly payments from your bank account. After the loan is paid off, you still have your savings.
If you don’t get the loan but spend down your own savings, there’s no guarantee you will build the savings back up. Although you can also set up automatic transfers to rebuild your savings, it’s just easier for people to find excuses to break those transfers than to default on a loan.
Poor Man’s Interest Rate Swap
From the recent media coverage about the LIBOR scandal, you probably heard many cities and other government agencies bought interest rate swaps from investment banks. They would pay a fixed interest rate to the banks and receive variable interest rates based on LIBOR from the banks. Because the LIBOR was allegedly set lower than what it should’ve been, the cities are suing the banks for what they should’ve been paid.
It’s a diversion. The interest rate swaps turned out to be a bad deal for the cities because LIBOR has come down big time since the cities bought the interest rate swaps. Even if LIBOR wasn’t set artificially lower, it would still come down a lot after the Fed set the Fed Funds rate to zero. Now the cities are still paying the fixed rate and getting practically nothing from the banks. Cities want to weasel out of the deal but then they face a large early termination fee. So they sue and create the impression that their ill fate is caused by the banks fudging the LIBOR.
Interest rate swaps are for the big boys. The savings secured loan from the credit union is a poor man’s interest rate swap. You pay a fixed rate on the loan and you receive a variable rate on the savings account. It’s a bad deal when the variable rate goes down or stays low but it could be a good deal if the variable rate shoots up.
It doesn’t seem likely we are getting back to 5% yield on money market funds any time soon. Back then I made a calculator just to figure out which money market fund is the best. Nowadays any money market fund is just as bad as the other.
Conclusion
Although I’m not going to take a savings secured loan, I see it can be helpful to some people for raising their credit scores and enforcing a savings discipline, plus a shot at rising interest rate.
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.
Pablo Honey says
I would be surprised to learn that they will use a variable rate for the savings account and a fixed rate for the loan.
More likely, they will fix the term of the collateral to match up with the term of the loan, and the rate would be locked on both.
Less likely, they will simply let both float and keep the 200 bps spread.
Least likely, they are going to take a chance of funding a fixed-rate asset with a variable-rate liability. (Hopefully they have learned their lesson on that approach!)
Harry Sit says
Pablo – The loan terms are as stated: fixed rate on the loan, variable rate on savings. Other than what acts as the collateral, it’s no different than fixed rate car loans or fixed rate mortgages. Only in this case the bank’s risk is lower and the borrower has a stronger incentive to repay the loan.
aram says
Your “cities want to weasel out of the deal” line implies that the banks were being honest and the cities are trying to take advantage of them. In fact, many of these interest rate swaps were bad deals at the time, and city officials were bribed into accepting them. See here and here for some stories on this.
Harry Sit says
aram – We have to keep in mind what’s the forest and what are trees. Banks depressed LIBOR during the financial crisis. By how much? Maybe 0.5%? Banks paid brokers to gain an unfair advantage in their bids. By how much? Maybe 0.25%? LIBOR was above 5% in 2006. It dropped below 1% in Q4 2008 and stayed there since then. The fairest interest rate swap paying fixed receiving variable would still be a huge money loser.
newbie says
I am not sure why one would take such a loan; it is like borrowing your own money and paying interest to someone else. There is no risk (except for maybe interest rate risk) which the credit union takes and they are asking for a 2% spread to cover for that, sounds pretty steep to me
Harry @ PF Pro says
I see no reason to take this loan, building credit is kind of a weak benefit IMO. Is there a certain situation in which you think it would make sense? At least with a mortgage or heloc the interest is deductible. This seems like kind of a sucker loan.
Harry Sit says
Harry – Mortgage, HELOC, and car loan require a good LTV and a good credit score. Other unsecured loans have much higher rates. This loan is easy to get at a very low rate. Compared to just spending the money on hand, I already gave the reasons: boost credit score, enforce a savings discipline, and possibly make money if interest rate shoots up.
Yes I Am Cheap says
I’m on the opposite side here, but if you happen to have cash sitting in an account (like my mom) that you have no intention of touching that is not your emergency fund, I would grab that cash and sock it into a higher interest rate svings vehicle such as a money market account or use it to pay high rate debt. But, that’s just me.
Mike says
Is there any tax write off benefits to a savings secured loan?
Harry Sit says
No.
Philip says
I don’t understand how this is not a win win if purchasing, say a car with the loan.
If you have 10,000 and buy the car you only have a car.
Let’s say it’s for 5 years you keep the car. You still only have the car and have spent your 10,000.
With this loan you freeze your money, and in the 5 years you have your money back and a car.
Sell the car and there’s your interest.
I do this against my 401k.
What I lose is the compounded interested but 10,000 for 5 years even at 7% is 4025.00.
But realistically it’s less because as I pay myself back which means the money being put back is gaining interest too.
Now I have the money and the car.
If I were to buy the car outright with 10,000, after the 5 years I only have the car.
If I were to take an auto loan, after the 5 years I’d also only have the car.
Is my reasoning wrong?
Harry Sit says
You didn’t count payments. When you use your $10,000 to buy the car, the payments you otherwise have to make if you got a loan will replenish the savings. After five years, you have the car and the savings built up from the payments. You only have the car if you spend the extra from not having payments.
Philip says
I understand your reasoning Harry. I should have made my statement clearer that I was contrasting against a conventional car loan, not the secured loan being mentioned in the article, if that’s what you’re discussing in your response.
I like the secured loan and I like borrowing against myself.
I’m interested in finding out if I am not seeing a “con” and just looking at my view of “pros” when I’m considering a car.
My father-in-law tells me I should never borrow against a 401k because of the compound interest. At 10,000 it doesn’t seem like a deal breaker but the numbers change drastically if it was a 50,000 loan so I would agree with him only with larger numbers.
John says
What I understand by you harry is that you use the $10000.00 to buy the car, and you would also save the monthly payments that you would have made for the next 5 years had you taken the $10000.00 loan to be repaid in five years. Am I correct?
Harry Sit says
Yes. That makes it apples to apples among (a) just spend the money you already have; or (b) keep the money but take out a savings-secured loan; or (c) keep the money but take out a regular car loan.
Elizabeth A Iveson says
So my mom took out a secured loan on her car they froze her money until the loan was paid for she paid off the loan with the 4000.00 that was frozen now she can’t her her money back what gives
Ernest says
My figuring is a pledge of 50,000 they are going to help your credit report. But if you have 50k in savings you already have a good credit report. They will take the money your paying 2 percent interest rates on and making .05 percent interest rate on and loan it out to some one else for 5.0 to 18.00 percent interest. If it were me I would put it into an account that pays 2.5 percent interest or bonds. There are a few options, or make a personal investment buying into a well established business or something. The problem with the united states economy is these shady banks and credit unions have been strip mining us of our money and assets with out actually giving us any thing for it. Mean while our government has given them billions in bail outs over the last several decades at 0 interest rates. How they need a bail out the way they do things is beyond me. If it was a 2000 or 3000 dollar loan to help build your credit I would say a few hundred to build your credit no Biggy. But 50k. Fix your old car its cheaper and invest your money in better ways. JS is all.
Travis bryant says
Wanting to upgrade my truck and borrow the money against my savings account. Don’t want to take money out of savings account. Pay back in 2 years.
Kimo L says
Does anyone know if Fidelity or a like Broker will give you a loan to buy a home and allow you to secure it with the assets you have invested with them in your Brokerage Account? Or alternatively, any Lender who will allow you to qualify for a mortgage based on securing your Investment Accounts vs. having income
I retired early and currently have very little income by design. In fact my only income is Dividends and a small amount of Interest I earn in my Brokerage Account. The figure is fairly small so it will not qualify me for a mortgage. I live off a cash balance I kept when I retired.
I could liquidate my Brokerage Account to buy a new home but the home will then in effect cost me 20% more as I will need to pay Cap Gain taxes on the investments I sell to buy the home. I probably won’t do this for a few years yet hoping interest rates come down not to mention home prices. I have been unable to find any information on Lenders that will allow for a mortgage qualification based on securing investment assets – if anyone has info on such it would be greatly appreciated.
kimo l says
Sorry I tried searching with some different terms and found the answer to my own question – something Harry wrote about in 2021 – here is the link. – https://thefinancebuff.com/how-to-use-securities-based-lending.html#htoc-where-do-you-get-securities-based-lending
I wish Fidelity handled it the same as Schwab – maybe I will have to move my money when the times comes.
Harry Sit says
There’s no practical difference between how Fidelity handles it and how Schwab handles it. Selling short box spread is another way to borrow against your investments. See Short Box Spread Trade vs Margin Loan: How It Works at Fidelity. Please put additional comments on this subject under those two respective posts because it’s more relevant there.