You can secure a debt using any form of collateral, including a savings account. A lender may permit you to use a current account you have as collateral on a loan. In other scenarios, a lender may ask you to open a new savings account to act as security against default. Both scenarios aren't favorable to the borrower and may not be worth the added risk.
A secured loan uses an asset as collateral on the debt. In general, secured loans are less risky for a lender and are therefore less costly for a borrower. Unsecured loans require no collateral, and they may be written using only a personal guarantee, usually in the form of a signature, for security against default. Loans secured with a savings account are essentially a hybrid of these two forms of debts. They do require an asset as collateral, but they don't necessarily offer the benefits of most secured loans.
A savings-secured loan can take a number of forms. Perhaps the most common form is a savings-secured credit card. In this scenario, you place a certain amount of cash in a savings account with the lender. The lender issues you a credit card up to a portion of the total value in the account. You use the card like any other credit card, spending up to your limit and paying down your balance. The amount of money in your savings account remains the same unless you default, in which case it's seized and liquidated.
You can also take a savings-secured personal loan. In this case, the lender extends you financing and places a lien on your savings account. You repay the debt in installments, and the lien is lifted if the loan is repaid successfully.
The main problem with a savings-secured loan is the relatively low asset-to-loan ratio. When you secure a mortgage, you may be able to get a 90 percent loan against the value of your home, requiring only a 10 percent down payment. With a savings account, the loan value is far lower. Typically, the lender will only extend 50 percent or less against the value of your savings account. Further, since your asset is already liquid, the lender can move quickly to seize your asset if you don't make payments. With a mortgage, the lender would have to wait several months and go through a foreclosure and sale process before evicting you from the property. If you place a savings account down, the lender only has to transfer the money out of the account if you default. Finally, you can't access your savings account and deplete its funds until your loan is paid off — the account is locked.
In most cases, securing a loan against a savings account offers little benefit. Secured loans are thought to be superior for many borrowers because of low financing costs and better terms. However, they're also riskier because the borrower can lose the asset in default. Taking this additional risk without accompanying rewards isn't advisable. Since savings-secured accounts offer few of the rewards of accounts secured with hard assets, they're not worth the added risk. Taking an unsecured loan may be a preferable option.
The Federal Trade Commission warns of secured credit card marketing scams. If a creditor asks you to deposit funds into an account before you have an established credit card contract, be wary of the deal. Always do your due diligence on a lender before handing over cash.
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