Pledged loans are a kind of secured loan that requires the borrower to pledge assets as collateral to secure funding.1 When you don’t have the money to purchase a vehicle or home outright, as most people don’t, some lenders may offer you a secured loan. Credit cards and personal loans are there when you need to make other important purchases.
Keep reading to find out how a pledged asset works and what other alternatives you have to borrow money.
Secured debt uses the value of an asset the borrower owns as collateral. The amount of money borrowed is secured through the value of that collateral. A loan that has been secured poses less risk to the lender, which may allow borrowers to access better interest rates, higher loan amounts, and longer loan terms. But if the loan is defaulted on, the collateral can be claimed and seized by the lender to make up for the funds lost on the defaulted loan.
Secured Loans vs. Unsecured Loans
|Secured Loans||Unsecured Loans|
|Collateral Required||Yes, an asset (like a home or car) is used as collateral.||No, these loans do not require collateral.|
|Interest Rates||Typically lower, as the lender uses collateral as a form of security.||Typically higher, as the lender is taking on more risk.|
|Loan Amounts||Often larger and based on the value of the collateral.||Usually smaller and based on creditworthiness.|
|Approval||Typically easier for borrowers with bad credit to get approval.||Approval often requires a good credit score and strong financial history.|
|Risk to Borrower||The lender can seize the collateral to recoup their losses in case of default.||The borrower’s credit score will be negatively affected.|
What Is a Pledged Asset?
A pledged asset is an item of value the borrower owns and is offered as collateral for financing. Pledged assets used as collateral can be many different things if their value exceeds the loan amount.
While the borrower retains ownership over the asset, the bank or other financial institution is given a partial ownership interest in the pledged assets used in secured loans. Suppose the borrower does not repay the loan according to the agreement and terms. In that case, the lender has the legal right to take the pledged asset used as collateral.
Examples Of Pledged Assets
Pledged assets can be almost any valuable item, such as real estate, vehicles, equipment, and investment accounts. In many cases, the pledged asset can help a borrower gain approval for a loan they may not have been approved for otherwise. Additionally, the use of the pledged asset to secure the loan amount could allow borrowers to get a lower interest rate than they would have had on an unsecured loan.
When the terms are fulfilled and the borrower has repaid the loan in full, the lender will transfer the ownership interest they had in the pledged asset back to the borrower. Some common pledge loan options include pledged asset mortgages and pledged securities using investments.
Pledged Asset Mortgage
In a traditional mortgage loan, the house’s equity is utilized as collateral, obviously. Still, typically lenders also require a down payment of 20%. A down payment is needed to prevent the mortgage from becoming underwater shortly afterward.
Homebuyers who wish to reduce or eliminate the need for a down payment can pledge assets to the bank after they obtain their mortgage. A pledged asset mortgage will provide the lender with additional collateral instead of the typical 20% or more down payment.
Additionally, the larger the down payment on a traditional mortgage, the lower the interest rates a borrower will be able to secure. By getting a pledged asset mortgage, the borrower may access lower interest rates without a 20% down payment and the private mortgage insurance that goes along with it. These perks incentivize more homebuyers to pledge an asset. According to the Federal Housing Finance Agency (FHFA), multifamily loan collateral increased from 2017 to 2018 by $22 billion (9%).2
Using Investments As Pledged Assets
A pledged asset mortgage is an excellent option for homebuyers and borrowers with investments they don’t wish to sell off to cover the down payment. Selling or accessing your high-yield savings account, mutual funds, certificates of deposit, or another kind of investment account for your mortgage down payment could trigger capital gains taxes that you don’t want to deal with right now.
A pledged asset mortgage allows your assets to earn interest and keep growing while you pay off the loan balance. A pledged asset mortgage tends to work well for high-income borrowers who have already done a fair amount of financial planning.
Benefits and Drawbacks of a Pledged Asset Loan
Just like with every other lending product, using pledged assets to secure a loan has its pros and cons. Before making any big financial decisions, it is always vital to understand both the benefits and drawbacks of your decision.
Some positive benefits of a pledge loan include the following:
- The borrower can often access a better interest rate by using pledged assets.
- The borrower’s high-yield savings account, securities, and other investments can keep earning additional funds despite being used as pledge assets.
- The borrower retains ownership of the valuable possession used as the pledged asset.
The drawbacks that may come with utilizing pledged assets or securities as collateral can include the following:
- Stocks or mutual funds may be difficult to transfer when used as securities.
- If the borrower defaults on the loan or mortgage, the lender could seize the pledged securities.
- When using pledged assets in place of a down payment, the borrower will end up paying more interest overall since the interest rate will apply to the total cost of the house.
- If the borrower’s assets decline in value over time, then the lender may request additional funds for security.
Alternative Options to Pledge Asset Loans
If you are unable to use pledged assets for security on your loans, there are other options for you to get the funding you need. However, you may need to pay a higher interest rate without any form of collateral. This is necessary for lenders to protect themselves from unnecessary risk.
Here are a couple of alternative options to pledged asset loans:
Unsecured loans do not require any kind of collateral for approval. The most common form of unsecured loans is a personal loan. Personal loans can be used for almost any purpose and come with various loan amounts and term lengths.
An unsecured personal loan may require an excellent credit score for affordable interest rates. Some lenders may charge higher interest rates for unsecured personal loans if your credit report isn’t in the best shape. But, on the positive side, there won’t be any valuable assets at risk, and you may be able to pay off your personal loan early to save money on interest.
Using a Co-Signer
Using a co-signer may help you get approved for an unsecured loan that you may not have been able to qualify for otherwise. Their income and credit score could help you access lower interest rates and a higher loan amount. But having a co-signer on your loan will make them legally responsible for the balance if you default. Therefore, it’s vital you make all your payments on time.
Bad Credit Loans
Most lenders have specific credit requirements in their loan application process. A borrower’s creditworthiness directly impacts the level of risk a lender takes when approving a loan application. This is why many lenders won’t approve individuals with poor credit.
With that being said, there are options for subprime borrowers. Bad credit loans include payday loans, title loans, and no credit check loans. Many of these unique loans tend to be short-term in nature and have very high rates. The interest rate is higher on these loans to compensate for the increased risk lenders take on by lending to higher-risk borrowers.
FAQs on Pledge Loans
How can a pledge loan help me build credit?
Like any other loan, making timely payments on your pledge loan may help you build credit if the lender reports to the major credit bureaus. Each on-time payment that gets reported could positively impact your credit history.
Can I get a pledge loan from a credit union?
Yes, many credit unions offer pledge loans. However, you must meet the strict eligibility criteria and pay a membership fee. It’s always good to compare rates and terms from different lenders, including credit unions, to ensure you get the best deal.
What happens if I default on my pledge loan?
If you default on a pledge loan, the lender can seize the asset you pledged as collateral. This could negatively impact your credit score and make it harder to obtain loans in the future.
Can a pledge loan help me get a lower interest rate?
Yes, because pledge loans are secured with collateral, they often come with lower interest rates compared to unsecured loans. This is because the lender has a lower risk if you default on the loan.
How does a pledge loan affect my payment history?
Just like any other loan, a pledge loan will affect your payment history based on how you manage the loan. Paying on time can positively impact your payment history, while late or missed payments can negatively affect you.
A Note from CreditNinja
A pledge loan could help borrowers get fast approval for loans. However, using collateral is risky and may result in additional financial issues for the borrower. Consumers are encouraged to thoroughly research all of their loan options before making a final decision.
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