What Is a Passbook Loan?

Understanding passbook loans

Passbook loans get their name from the small passbooks banks used decades ago to record deposits and withdrawals. Though many banks don’t hand out paper passbooks anymore, the term stuck and is often used interchangeably with savings-secured loan or CD-secured loan.

What makes passbook loans different from other loans is how they’re backed. Unlike unsecured personal loans, where your approval is based on your credit history and income, passbook loans rely on collateral (your savings balance in this case) to help guarantee that you’ll repay the loan. Since the bank already has your collateral, that makes the approval process faster and easier.

Passbook loans are different from simply withdrawing from your savings. Instead of spending your cash and reducing your account balance, you keep your money intact and borrow against it. This lets you keep earning interest while you make loan payments.

So, if you’ve been turned down for other types of credit, consider looking into passbook loans. Compared with other financing options, they’re generally more accessible and low risk for both you and the lender. The interest rate is generally lower as well: around 3.5% annual percentage rate.

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How passbook loans work

When you take out a passbook loan, the bank sets aside the amount you want to borrow and freezes it in your savings account or CD. You won’t be able to touch those funds until the loan is completely repaid, but they’ll stay in your account and continue to earn interest.

Since your bank is lending money against funds it already holds, you generally don’t need to go through a lengthy approval process to get a passbook loan. Most applications can be completed directly through your bank or credit union.

The loan amount is typically up to 90% of the amount in your savings. For example, if you have $5,000 in a savings account, you may be able to borrow up to $4,500. Repayment works like any other installment loan. And as you pay down the loan, the bank will release the same amount from your frozen savings funds.

Once you’ve made all your payments, the bank lifts the hold on your savings, and you regain 100% of your savings collateral. In the meantime, making on-time payments can help build your credit history.

Advantages and disadvantages of passbook loans

Consider these pros and cons before taking out a passbook loan:

Advantages of passbook loans

• Lower interest rates compared with unsecured personal loans or credit cards
• Easier qualification requirements
• Build credit
• Savings continue to earn interest

Disadvantages of passbook loans

• Locked savings until the loan is repaid
• Loss of savings if you default
• Charges interest on your own money

Eligibility and requirements for passbook loans

Getting approved for a passbook loan is quite straightforward. You’ll typically need to have a savings account or CD with the bank offering the loan, and that account typically needs to be in good standing. Some banks may also set minimum balance requirements.

Since the loan is secured by your own funds, you don’t need a high credit score to qualify. In many cases, the application only asks for basic identification and account details. Some lenders may request proof of income, but requirements are generally more lenient compared with other loan types.

The amount you can borrow is directly tied to your savings. Many banks cap it at 90% to reduce their risk, though some may let you borrow up to the full amount.

Alternatives to passbook loans

If you need money but don’t want to deplete your savings directly, a passbook loan can be a solid way to access funds while building credit at the same time. But if you prefer not to tie up your money at all or only want to build your credit, look into these alternatives instead.

Unsecured personal loans

As the name suggests, unsecured personal loans don’t require collateral, which means you can borrow without tying up your money or other assets. The downside of this is that interest rates are usually higher since these loans are riskier for lenders. That said, if you have a good credit score, you may still be able to get reasonable rates.

Credit-builder loans

Credit-builder loans are designed to help you raise your credit score. So if that’s your main goal, getting a credit-builder loan may make more sense than taking out a passbook loan.

With credit-builder loans, the lender will place the funds in a savings account or CD instead of giving you the loan money upfront. You then make monthly payments, and once the loan is paid in full, you get access to the money. Since there’s little risk for the lender, these loans are easier to qualify for, especially for those with poor or no credit history.

Secured credit cards

You can also consider secured credit cards if you want to build your credit. With these cards, you provide a cash deposit upfront, and that deposit becomes your credit limit. You then use the card for purchases and pay it off monthly, just like a regular credit card. If you make on-time payments, your activity gets reported to the credit bureaus, which helps build your credit over time.