Passbook Loans

A passbook loan is a loan from your bank or credit union, which uses the money in your savings account as collateral to guarantee the loan. In other words, if you have $5000 in your savings account and want to spend $2000, you can ask the bank to give you a $2000 passbook loan using your savings as collateral. This way your savings remain intact - although you cannot use the amount offered as collateral until it is repaid - and you continue to earn interest on the account. You repay the passbook loan by making regular repayments to the bank - but if you fail to make the payments, the bank can take the cash owed, plus costs, from your savings.

Some banks and financial institutions will allow customers to borrow up to 100 per cent of the money in their savings accounts, while others have a much lower limit allowed for passbook loans. Interest rates on the money borrowed also vary greatly depending on your bank, credit union, or financial institution; however, the interest rate payable on your passbook loan will be two or three percent higher than the interest you are receiving on your savings account.

It can take quite a long time to build up a savings account, and many people would prefer not to empty that cache and start all over again when faced with the need for a major purchase, unexpected large expense, financial emergency, or even just to buy a luxury item or holiday without leaving a financial cushion. A passbook loan allows you to keep your savings account intact by borrowing against it; your bank will advance you funds based on its policies as a passbook loan, and you make regular loan repayments as on any other loan. The difference is that you still have money earning interest in your savings account, which, of course, looks good on your total financial picture.

Some people take out a passbook loan in order to build or rebuild their credit rating. However, it is important to remember that many banks do not report passbook loans to credit agencies, so your timely repayments on your passbook loan may not appear as part of your good credit rating. It is a good idea to ask about this credit agency reporting at your financial institution before you sign on the dotted line for a passbook loan.

When your bank approves your application for a line of credit, you have a specific amount of money in a loan account that you can make withdrawals from as you wish, up to the maximum amount in the account. A line of credit is usually dependent on the customer offering the bank some collateral, such as a property, home equity, or less common, stocks and shares or an interest in a business. Financial institutions have a "loan to value" ratio, which they use to determine how much money they will approve for a customer's line of credit, and this may vary from institution to institution.

A line of credit usually has a period of time when you can withdraw money from the account without making repayments; after that time, you will be expected to begin repaying the money you have borrowed on your line of credit. These repayments will include both principal and interest amounts.
Line of credit loans may vary greatly in the interest rate the financial institution charges, so be sure to ask about interest rates when you apply for your line of credit.

Most lines of credit involve the borrower offering the bank collateral in the form of a substantially valuable item, and for most people that is their home. Usually, a line of credit is based on the value of the client's equity in their home.

However, a line of credit differs from a home equity loan in that it is more flexible and can be more accurately tailored to your needs. A home equity loan, which is like a second mortgage, is a fixed sum of money that you borrow and then pay back on an agreed repayment rate.

By contrast, a home equity line of credit means that the bank sets an agreed amount of money available in your line of credit loan account which you can then draw on in amounts that you need - so you are only paying interest on the actual amount you have withdrawn at any one time. You usually access your line of credit by a checkbook, and if your borrowing needs are less than you expected, you will have a smaller amount of money borrowed. If you have a home equity loan, you have borrowed a fixed amount and must repay the principal and interest on that amount, even though you may have not needed the entire sum for the project you borrowed it for.

A line of credit usually has a variable interest rate, while the interest rate on a home equity loan can be either fixed or variable depending on the type of second mortgage you take out. Fixed or variable rates of interest each have their own advantages, depending on the state of the economy at the time you sign the deal.

In both home equity loans and in lines of credit, the reason the bank is loaning you the money is that you have valuable equity in your property and a reasonable expectation of being able to pay the loan back. If for some reason your financial situation changes and you are unable to keep up with the loan repayments, you can expect that the bank may foreclose and you may lose the property. If the property is sold, whatever is left from the sale price after the bank has received the unpaid loan amount plus its fees and penalties is paid to the former owner.

As with all loans, lines of credit and home equity lines of credit have interest rates, fees, and bank charges which you should always inquire about ahead of time and factor into your budget.

Obviously, this depends to some degree on your personal financial situation and your income stated on your tax return, but in many instances, it is possible to get a tax deduction on the amount of interest you pay on your home equity loan or line of credit. This can help you save money on the cost of borrowing against your home equity - or the equity in a second home or property. It is important to remember that there are limits to the amount you can claim on, and this usually applies only to the interest you have paid, not to the fees and penalties levied by your financial lender. Usually, the tax deductions only apply if the money has been used for items such as home renovations or debt consolidation. This is where a consultation with an accountant or other financial adviser would be beneficial before you take out the home equity loan or line of credit.

When talking about finance matters, collateral means an asset, property such as a home, cottage or investment property, or other valuable items like stocks and shares. Sometimes, collateral loans are made on assets expected to occur in the future - an example of this is in farming, where a farmer may borrow money against the expected profits from crops later in the year. Occasionally, although much less common, a bank will accept high-priced goods such as sailboats, jewelry, etc., as collateral for a loan.

The borrower pledges the asset or collateral to the financial institution in exchange for the use of the bank's money in the form of a collateral loan. When the loan is paid back, the bank no longer has any rights to the collateral property. If the borrower is not able to pay off the loan or misses payments, the financial institution can take possession of the collateral and sell it to recoup the money involved in the loan. Any money remaining after the bank has taken the unpaid loan amount plus interest, late payment penalties, and fees must be returned to the borrower.

In banking circles, this is known as secured lending or asset based lending.
Some financial institutions offer a slightly lower interest rate on a collateral loan than they offer on an unsecured loan, because having rights to the collateral gives them some security against the possibility of the borrower defaulting on the repayments.

It might sound like a straightforward financial deal, but in the present economy, you should consider the possibility that the collateral you are offering in exchange for your collateral loan may well go down in value. For example, imagine if you offer your home, valued at $250,000, as collateral for a loan of $200,000. Suppose there is a sudden downturn in the economy or your town is hit by a hurricane and suddenly your home is only worth $175,000 (or even less, if it was in the path of that hurricane!). This means that the collateral you have offered the bank is now worth less than the amount of the collateral loan you have agreed to. Everything should be all right if you continue to make the repayments on time - but if you default and the bank forces the sale of your now devalued home, you will be liable for the difference between that sale price and the amount of the loan that is still outstanding. You may have to sell off other assets in order to repay the full amount of the collateral loan. For this reason, most people rarely borrow to 100 per cent of the value of their property on a collateral loan.

It is important to remember that your passbook loan, line of credit, home equity loan, or collateral loan all will have interest charges and bank fees you will have to repay in addition to the actual amount borrowed. In home equity and collateral loans, in particular, it's probably wise not to borrow to the full amount of the property, or you could find you owe more than it is worth when all the interest and fees are added up.

As long as you keep up with the repayments, you continue to own the equity in your home, or continue to have your savings. It's rather like having your cake and eating it, too!

At the same time, anyone considering such a loan must be aware that there are pitfalls. All these loans depend on the customer offering some kind of collateral, whether it is equity in their home or property they own, the money they have saved in a savings account, capital investments, high-priced possessions, or other goods. If the loan is defaulted on, then the bank or financial institution can foreclose on any of these items - whether it is the money in your savings account, your home, or any of the items listed on the loan agreement.

A passbook loan, line of credit, home equity loan, or collateral loan can be your doorway to accomplishing a personal dream, whether it is a holiday, a home extension or renovation, a college fund, debt consolidation, or anything else

A wise borrower will be aware of his or her own capacity to repay the money borrowed on time, and will shop around for the best deal and read the small print very carefully before signing.