As most of us learn once we become adults, money has a weird habit of vanishing almost magically. We employ a wide range of psychological tricks to stop ourselves from just YOLOing that cash out into the universe, and sometimes those tricks actually work and we manage to put together a tidy sum in a savings account. The average American, in fact, has more than $60,000 in savings (not counting retirement accounts)—although that number is a little deceptive, as the median average amount of savings is just $8,000, meaning half of Americans have less than $8,000 in savings. If you’re like most Americans, though, eight grand (or even significantly less than eight grand) is still a lot of money—and it’s not easy to save it.
That’s why sudden, large expenses are so tragic—you’ve put so much effort into building up your savings, and now a roof repair, car repair, or medical bill is going to wipe all those savings away. It can be demoralizing to see your savings vanish into the void—plus, if you have to use everything you have to pay a big bill, you’re left with no emergency fund. Luckily, if you have savings there’s another option worth considering: a passbook loan.
Borrowing from yourself
A passbook loan (aka a savings pledged loan) is a loan secured by your own money. With a passbook loan, your bank freezes the portion of money you’re borrowing, but leaves it in your savings account. Then you pay the loan back as with any other loan, and as you do so the bank releases your savings back to you. You’re essentially paying to borrow money from yourself.
For example, let’s say you have $5,000 in your savings account, and you need to repair your roof (average cost: $1,150). You can take the money from savings and pay the repair bill, but then you would simply lose that money. Or you could charge the repair to a credit card and keep your savings intact—but wind up paying high interest on the loan. Instead, you can take out a passbook loan. The bank freezes $1,150 of your savings, and as you pay the loan back that money becomes accessible again.
Benefits
Borrowing from yourself—and paying for the privilege—might not seem like such a hack at first blush. If you simply pay the bill from your savings, you avoid paying interest on top of it. But there are several reasons why a passbook loan can make a lot of sense:
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You keep your savings. It’s not easy building up savings. If you have a nice little nest egg, depleting it to pay a bill is depressing—and there’s no guarantee you’ll be able to save that amount ever again.
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The interest is low. Because a passbook loan is secured against the money you already have in your account, you typically get a really great interest rate—often as low as 2%. It will definitely be cheaper than a personal loan or a credit card (unless you can get a 0% deal, although those have their drawbacks as well).
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The paperwork is minimal. Because you’re a customer of the bank, passbook loans are usually easy to arrange, without all the fees and red tape that personal loans incur.
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You’re still earning interest. The money you borrow is frozen in your account, meaning you can’t access it until you pay back the loan. But it will still earn interest, which helps to both keep your savings plan on track and defray the overall cost of the loan—at least you’ll be getting some money back.
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You build credit. If you have a poor credit score, a passbook loan is a good way to build your credit because it is similar to a secured credit card. Your credit score won’t matter because you’re securing the loan with money the bank already has, so there’s zero risk to them, but paying it back on time will probably improve your credit score. Not all banks report passbook loans to credit bureaus, though, so this is something you should check on before assuming anything.
If you can’t get a loan from other sources because of your credit history, a passbook loan might be your best—and possibly only—option to avoid draining your savings to cover an unexpected expense.
Setting up a passbook loan is pretty simple. All you need is a savings account or certificate of deposit (CD) account with sufficient funds to cover the loan amount. Most banks will loan you up to 90% (or even 100%) of your account balance as a passbook loan, and often they have flexible payback terms that allow for pre-payment, so you can get the loan taken care of as quickly as possible.
Drawbacks
A passbook loan might not be ideal for everyone. There are some downsides to consider:
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The amount of money you can borrow is limited by how much you have in a savings account or CD. If you don’t have enough in your savings account to secure a loan of the required amount, you will need to look for other loan options.
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If you borrow a big portion of your savings, you lose access to that money. If another emergency expense comes up you won’t be able to use your savings to pay it, which might push you into an additional (and possibly more predatory) loan.
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If you default on the loan, you don’t just suffer a lower credit score and a growing debt—you will literally lose the savings you used to secure the loan.
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Even though interest rates on passbook loans are low, it will still cost more than simply paying the bill with your savings.
