Some banks let you borrow the full amount you deposit and pledge as collateral. Others limit the loan-to-value ratio to around 90% or less. For example, for every $100 in your account, the lender might allow you to borrow $90.
If your primary goal is to build credit, you don’t need a massive loan. Several thousand dollars should be plenty, and it’s common to start with loans smaller than that. Some banks offer cash-secured loans for up to $100,000, but the maximum amount depends on your bank or credit union.
Most cash-secured loans come with relatively short repayment terms, such as ten years or less. Those loans can best help you through tough times while improving your credit scores.
To repay lump-sum loans, you typically make equal monthly payments throughout the term of your loan. A portion of each payment reduces your loan balance, and the remainder covers your interest cost.
You don’t need to go big to take advantage of these loans. If you’re just starting to build or rebuild credit, ask about borrowing a few hundred dollars. A smaller loan is less burdensome on your finances. You only lock up as much money as you have to, and you can keep interest costs low with a small loan.
You might wonder why you’d ever bother with a loan when you already have cash available. In some cases, just spending the money makes sense, since you’ll avoid paying interest, keep your debt level low, and avoid damage to your credit if you stop making payments.
If you have bad credit or you’ve never borrowed in the past (known as having “thin” credit), these loans can be a stepping stone toward higher credit scores. Every time you successfully pay off a loan, your credit improves-as long as your lender reports the loan to major credit reporting agencies.
Offset Interest Costs
If you choose to pay interest to rebuild your credit through a loan, it’s beneficial to make up for some of those costs by earning interest on your savings. It makes sense, though, to borrow and pay interest only if you’re receiving other benefits.
When you use your cash as collateral, the money gets locked up until you pay off the loan and close your credit account. You might be able to access some of your money after you partially repay the loan, but in the meantime, your money continues to earn interest, although probably less than you pay on the loan.
Keep Savings Intact
There’s also a behavioral benefit. If you have difficulty saving money, it might not be a good idea to use up your emergency savings, because you’ll need the discipline to rebuild that fund, and you’ll have to start from zero.
Borrowing against your savings provides a structure that encourages you to make the required payments, and it discourages you from using credit cards to pay for emergencies. Once you pay the loan off, you will still have a sum of cash available for future needs.
Better Loans in the Future
Ultimately, the difference between what you earn on savings and what you pay on the loan should buy you better credit and potential psychological benefits. You may qualify for lower interest rates on significant loans in the future-to buy a house or car, for example.
With improved credit and cash available for a large down payment (because you maintained your savings intact as collateral), you may qualify for better terms on larger loans. Low rates and better options can result in significantly lower lifetime borrowing costs.