There are an abundance of ways to borrow money when you are in need of some extra funds. When you don’t have the money to purchase a vehicle or home outright, as most people don’t, there are lenders that can offer you a secured loan like a mortgage or auto loan. Credit cards and personal loans are there when you need to make other important purchases.
Whatever your needs, you are likely going to find a financial institution that can meet them. Empowering yourself to navigate the world of personal finance with finesse will be incredibly helpful to your overall quality of life. To do this, it’s a good idea to get a grip on the financial terms that can be confusing at times.
Pledged loans are a kind of secured loan that relies on pledged assets as collateral to secure the money you are borrowing. Keep reading to find out how a pledged asset works and what other alternatives you have to borrow money.
Secured Loans
A secured loan uses the equity value of an asset owned by the borrower as collateral. The amount of money borrowed is secured through the value of the collateral. A loan that has been secured poses less risk to the lender, which can allow borrowers to access better interest rates, higher loan amounts, and lengthier loan terms.
The asset or assets you use as collateral to secure a loan are called pledged assets because you are pledging them to the lender in the case the loan is not repaid. If the loan is defaulted on, the collateral can be claimed and seized by the lender to make up for the funds borrowed and lost on the defaulted loan.
What Is a Pledged Asset?
A pledged asset is an item of value owned by the borrower and offered as collateral for financing. Pledged assets used as collateral can be many different things as long as their value exceeds the overall loan amount.
While the borrower retains ownership over the asset, the bank or other financial institution is given a partial ownership interest in the pledge assets used in secured loans. If the borrower does not pay back the loan according to the agreement and terms, the lender has the legal right to take the pledged asset used as collateral.
Examples Of Pledged Assets
Pledged assets can be all kinds of items that have value, from real estate and vehicles to 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, but 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 they are obtaining their mortgage from. A pledged asset mortgage will provide the lender with additional collateral in the place of the typical down payment of 20% or more.
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 will be able to access lower interest rates without a 20% down payment and the private mortgage insurance that goes along with it.
Using Investments As Pledge Assets
A pledged asset mortgage is an excellent option for homebuyers and borrowers who have 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.
Using investments in a pledge 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 pros and cons. Before making any big financial decisions, it is always vital to understand both the benefits and drawbacks of the decision you are considering.
Some positive benefits of a pledge loan include:
- The borrower can often access a better interest rate when they are using pledged assets as collateral than the rates available with unsecured loans.
- The borrower’s high-yield savings account, securities, and other investments can keep earning additional funds while they receive your loan. Additionally, saving borrowers from capital gains taxes or high tax penalties.
- The borrower continues to retain 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:
- Stocks or mutual funds may be difficult to transfer when used as securities, so the borrower will need to ensure that their assets are able to be pledged.
- If the borrower defaults on the loan or mortgage, the lender could seize the pledged securities, which could be detrimental to the borrower’s savings and financial well-being.
- When using pledged assets in the 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 as time goes on, 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, it should be noted that 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 pledge asset loans:
Unsecured Loans
Unsecured loans do not require any kind of collateral for approval. The most common form of unsecured loans are personal loans. Personal loans can be used for almost any purpose and come with a wide range of loan amounts and term lengths.
Personal loans that are unsecured may require an excellent credit score if you want to get competitive and affordable interest rates. Be prepared to pay 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 can pay off your loan early to save money on interest.
Using a Co-Signer
If you don’t have collateral to secure your loan, you can always rely on a co-signer to be approved. Using a co-signer can help you get approved for an unsecured loan that you may not have been able to qualify for otherwise. Having a close friend or relative co-sign your loan will make them legally responsible for the balance if you default on your loan. Their income and credit score could help you access lower interest rates and a higher loan amount.
It’s crucial for them to understand the responsibilities that come with being a co-signer. Additionally, it’s vital you make your payments on time and handle your loan with great care so as not to put your co-signer in an uncomfortable position.
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. It’s for this reason that many lenders won’t approve individuals with poor credit.
With that being said, there are options for subprime borrowers. Loans for people with bad credit 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.
Working on improving your credit score can help open up the number of opportunities that will be available to you in the future. Building your credit can have an extremely positive effect on many aspects of your life, including the ability to obtain affordable loans. To boost your credit score, pay down a majority of your debt and check your report regularly to dispute any inaccuracies or inconsistencies.
References:
What is a Pledged Asset Mortgage (PAM) | American Financing