The passbook loan is a secured personal loan. In order to qualify for it, you must already have funds on deposit at the bank or credit union that you make application to. Funds are usually deposited in a savings account or a Certificate of Deposit (CD). The bank will loan you money and take a collateral interest in the deposited funds until the loan is repaid.

This type of loan is often made without a credit check. Since the money being loaned is secured by deposited funds (in other words, in the bank’s possession), the bank experiences no risk. The deposited funds are frozen and unusable by the borrower until the debt is paid. The interest rate charged is generally two- to three percent higher than the interest rate being paid on the deposited funds. For example, if the savings account is drawing two percent interest, the rate charged for the loan would be four- to five percent. This gives the bank a two- to three percent profit, along with the security of a no-risk transaction. The repayment term can be from one- to ten years, depending upon the amount of the loan.

Some banks will lend up to 100% of the savings balance. Others will lend no more than 50%, which serves to increase their security. As the balance of the loan decreases with repayment, a corresponding portion of the collateral account is “freed up”, allowing the borrower access to those funds again. When the loan is completely paid off, the borrower once more has full access to all of his or her deposited funds.

If a borrower already has money on deposit in the bank, why use this type of loan? There could be several reasons. For one, it’s very difficult for many people to save money. Once it’s used, it has to be replenished. Many people would rather keep their savings in the bank, because when they’ve repaid the loan, the savings will still be there. And even though they’re, in essence, paying to borrow their own money, the relative cost of this type of loan is small for the comfort level that it gives.

Other individuals use passbook loans as a credit-rebuilding tool. The loan is easy to get, and allows them the opportunity to establish a track record of timely repayment with a financial institution. However, some banks do not report passbook loans to the credit bureaus. Potential borrowers must be sure that the bank or credit union that they are doing business with will report the account to all three bureaus; if they don’t, this type of loan does them absolutely no good.

If you can afford not having access to your savings account temporarily, then the passbook loan can be a very cost-effective instrument to meet your short-term financial needs. It’s easy to obtain, inexpensive, and can also help to put your credit back on track. And if you need money but you simply don’t want to use your savings, it can fill the bill nicely

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