Passbook Loan: Meaning, How it Works, Pros and Cons

What Is a Passbook Loan?

A passbook loan is a personal loan made to a savings account holder by the custodial bank, which uses the savings account balance as collateral. These loans may also be called a savings pledged loan, and another version is called a certified pledge loan.

How a Passbook Loan Works

With a passbook loan, the savings account holder continues to earn interest in the savings account, including the amount borrowed. As the loan is repaid, the account holder gains access to those funds.

Terms and conditions vary considerably, with some lenders willing to lend up to the account's balance, although others only lend a percentage. For example, a passbook loan with Community Savings Bank will allow customers to borrow up to 90% of their available balance.

Passbook loans are considered low-risk transactions for the lender due to the accessibility of the collateral. The borrower must hand over the passbook to the bank until the loan is repaid. The bank can also place a hold on the savings account funds up to the loan amount.

Advantages and Disadvantages of a Passbook Loan

Basically, a passbook loan is a loan you take out against yourself. You are borrowing from your bank or credit union using your savings account balance as collateral.

A passport loan can help you if you need to establish a good track record of paying back your debts, which can help you improve your credit history.

Another reason to use a passbook loan versus a personal loan is that you'll be offered a lower interest rate on a passbook loan by your bank or credit union. What is the interest rate on a passbook loan? It depends on the institution issuing the loan. For example, BankFive in Massachusetts and Rhode Island has an interest rate for its "collateral loan" product of either 3% or 3.5%.

A passbook loan keeps your money (and the loan funds) in one place, which may be reassuring to a nervous borrower or saver. Plus, your savings account will still earn dividends.

The downsides of a passbook loan are that If the bank doesn't report your loan history to the credit agencies, it won't be added to your credit history. If you default on the loan, you lose your savings, which are the collateral to the loan. That, in turn, could leave you without funds for an emergency or deplete your savings, which you might have been planning to use for major expense like a down payment, new car, or a holiday.

Also, you will be essentially paying interest on your own money, and missing a payment will often result in late fees. Some banks or credit unions may require a $5 or more balance in your savings account in addition to the money you use for collateral.

The Bottom Line

Passbook loans allow you to use your savings account as collateral for a loan. Most banks and credit unions let you borrow up to 100% of the amount in your account. These loans may offer lower interest rates than a credit card or personal loan secured without collateral. 

Remember, if you take out a passbook loan, you will be essentially paying interest on your own funds. But a passbook loan may help your credit score if your lender reports your payments to the credit agencies.