A savings-secured loan (SSL) is a type of fully-secured credit builder loan that allows borrowers with limited, zero, or damaged history to obtain installment debt at favorable rates by pledging their savings as collateral. SSLs rarely require credit checks because they are 100% backed by cash.

SSLs are also known by various names such as "share-secured loans," "certified loans," "pledge loans," "certificate-secured loans" and "passbook loans." However, SSLs are not the same as share-pledge loans, which use shares (and not cash) in a credit union or other company as collateral.

They are often marketed as funding tools, but borrowers can save on interest by using their savings instead of pledging them against the loan. Instead, SSLs are ideal credit building tools.

Summary

Definition

Savings-secured loans are a type of consumer loan that use the borrower's deposit as collateral.

Are they a good idea?

Savings-secured loans are safe, non-predatory options. While they are excellent credit-building tools, they are not good financing tools and rely on borrowers' fear of losing savings rather than providing legitimately superior terms.

SSLs Have Better Rates

The primary advantage of savings-secured loans is lower rates. They can be anywhere from 20% to 80% less than personal loan rates¹. For example, Patelco Credit Union's average SSL APR is 2.38% and its average personal loan APR is 13.20%.

SSLs Often Require No Credit Check

The use of cash collateral provides reassurance to lenders, and in most cases savings-secured loans do not require a credit check. This makes them ideal options for borrowers with cash reserves but poor credit.

How It Works

SSLs distribute principal upfront and require a fixed number of equal payments like traditional loans, but they provide lower interest rates.

The reason they can provide lower rates is the use of cash pledged as collateral. The borrower agrees to lock up his/her savings account for the duration of the loan and to forfeit it in the case of default.

To understand why collateral reduces interest rates, consider the purpose of interest. Interest is compensation borrowers pay a lender for the use of a lump sum of money. It's also a way to convince the lender to take a risk on the borrower, who may never reimburse the funds.

In other words, an interest rate is composed of base payment + risk mitigation. For example, 10% interest can be 7% payment and 3% risk mitigation.

A Type of Secured Loan

A borrower can remove that 3% of interest by limiting the lender's risk in a way other than interest, such as promising to hand over an asset. Think about lending money to a friend but requiring she give up her motorcycle in case she can't reimburse you.

This is called collateral, also known as security. Loans that use collateral to mitigate risk are called secured loans.

Secured loans can use physical assets as collateral. The most common example of this structure is mortgages, which use a house or other real estate to back the loan.

Other types include title loans, which use vehicles as collateral. Pawnshop loans use small assets like jewelry.

The issue with homes, vehicles, and jewelry is that the lender does not know how to sell them once it repossesses. The same is likely true of the example in which your friend forfeits her motorcycle.

Assets that are hard to sell are called illiquid. In a sentence, the harder it is to sell something for cash, the less liquid it is.

Savings as Collateral

The use of savings as collateral not only minimizes lender risk but also provides the most liquid asset on Earth—cash. It is the ideal compensation to lenders, which explains why rates are so much lower than normal personal loans.

Savings are Locked

Savings pledged as collateral are inaccessible during the loan. This means the borrower places those funds in a secured account, and secured accounts offered by lenders usually generate interest. The most common forms are interest-yielding savings accounts and certificates of deposit.

In many cases, borrowers have savings locked in one of these accounts as an investment. When the need for funds arises, those savings are available as collateral.

Unlocking

There are two ways savings-secured loan collateral becomes unlocked. First, the funds are locked until the loan is repaid in full. Second, each installment payment unlocks an equivalent portion of savings. The lender decides which structure to make available.

Amount

Unlike most loans, SSL amounts are dependent on borrower creditworthiness. Instead, they usually have a trivial minimum amount of several hundred dollars and a maximum amount equivalent to the amount of savings collateral on account.

Not a Funding Tool

It is rarely to the borrower's advantage to use savings-secured loans for funding purposes. The reason is that the borrower can simply use his/her savings to fund the purchase rather than pay interest on an SSL.

An exception can occur when a borrower already has money locked in savings at the time of the funding need. Savings accounts can impose a penalty for early withdraw.

Penalties are lender-specific but are usually equivalent to account yield for a number of months, for example 6 months yield on a 3-year deposit. If the penalty exceeds interest on the loan, then using the loan is as a funding tool is advantageous.

It's worth repeating that the exception only applies when the borrower already has funds in a locked savings account. There is no reason to move savings to a locked account solely for the purpose of obtaining a low-rate SSL.

The Endowment Effect

The reason borrowers use SSLs for funding purposes is a cognitive bias known as the endowment effect. The endowment effect states that people tend to value object more when they own them.

For example, a popular study demonstrated that students were willing to pay $5 for a mug but would only resell it for $15.

The endowment effect applies to savings-secured loans because people value their savings enough to pay interest on the same amount of money, simply because they don't "own" it.

The inefficient use of SSL as funding tools does not mean they have no purpose. On the contrary, SSL are excellent tools for building credit.

Impact on Credit

The purpose of credit building is to pay low fees in the present in order to save on future interest.

For example, borrowers that take out a 12-month $1,000 SSL at 3.50% effectively pay $16 in order to improve their profile.

The credit improvement allows them to obtain a mortgage at 4% versus 5%, which can save over $100,000 on a 30-year $500,000 loan.

In other words, they pay $16 now to save $1000s in the future.

Ideal Borrowers

To summarize, borrowers that have locked savings accounts with heavy penalties can benefit from SSL's low rates. Additionally, borrowers with a lump sum of savings who want to build credit in order to save on future loan interest can use low-interest SSLs.

Savings-secured loans are best used as one tool in a larger credit building toolbox.

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