What Is a Pledge Loan and How Does It Work?

Pledge Loan Meaning

Suppose that you face a financial emergency or need money for a major life project. If you have good credit, it won’t be a problem for you to borrow money from a bank or credit union. But people with credit issues are often forced to turn to various expensive alternatives.

However, there are more favorable options to consider with less-than-perfect credit. If you have some valuable property to use as collateral, you can get a secured loan, also known as a pledge loan. But what is a pledge loan working mechanism, and is it risky to get one? Let’s find out!

Pledge Loan Meaning

In accounting, pledging is a process of ensuring financial obligations by setting aside a specific asset. Thus, a pledged loan is a type of borrowing that requires an applicant to provide some valuable belongings to secure the loan. Simply put, it allows you to access the needed amount in exchange for a property you own. The pledge you provide will be used as a repayment guarantee. Thus, it can be repossessed if you fail to repay the loan on time.

Pledged loans are known for their lower minimum credit score and income requirements. Therefore, they are popular with bad credit borrowers. Also, a pledged loan can be a reasonable alternative to a personal loan for people who seek higher loan amounts or want to get more favorable loan terms. As a pledged asset loan carries less risks to the lender, it’s more likely to offer you lower interest rates or extended repayment terms.

Understanding of Pledged Assets

Pledged assets are possessions or personal effects that a lender uses to offset the risk of losing money it lends to a borrower. A pledged asset must be owned by an applicant and have a value that equals to or, more often, exceeds the loan amount. By providing a pledged asset, a borrower can reduce the interest rate or down payment. Additionally, pledging can sometimes be the only way to qualify for a loan with less-than-perfect credit.

How Does a Pledged Asset Work?

According to a secured loan agreement, a borrower retains ownership of the asset they pawn. They keep using it as usual and get all dividends or other earnings within the whole loan lifetime. However, a borrower may not be allowed to sell the asset pledged as it can be considered a criminal offense. This is because a lender receives a partial ownership interest in collateral, so when you sell it to a third party, you technically steal the lender’s property.

As a pledge is a kind of repayment guarantee, the lender can seize it if the borrower violates repayment terms. But if the debt is fully paid off, the borrower gets the collateral or the lender’s partial ownership of it back.

Pledge Asset Examples

If your property has value and can be sold at auction or in a private sale, it can be used as collateral. Below are some of the most popular pledge asset categories.

Using Your Property As Collateral

This is the most popular way to secure your loan. You can get the funds you need against the cost of your car, house, jewelry, household appliances, and more. Some types of loans, such as mortgages and auto loans, use the property you’re going to buy as collateral. Others, such as secured personal loans, require you to provide property you already own.

When it comes to personal loans, you will be able to get just a portion of your asset’s estimated price. The exact sum can range from 50% to 85%.

Using Your Investment As a Security Pledge

If you have high-yield savings accounts, bonds, ETFs, mutual funds, money market funds, certificates of deposit, or other kinds of investments, you can also use them as pledge assets. The main benefit of pledging your investments instead of selling them lies in no capital gains taxes applied. Plus, you can still earn interest or get dividends from your investments.

But keep in mind that you risk losing your investment if you won’t be able to repay the loan. Therefore, assess your financial situation thoroughly to prevent financial risks.

Using Money in Your Savings Account

Your savings can also be used as pledged securities and increase your borrowing power. If you don’t want to withdraw money from your savings account, let it help you get better interest rates on a loan. While you’re paying off your loan balance, the amount of savings used as a pledge also reduces.

Pledged Asset Loan Examples

Below are some examples of pledge loans that people often turn to.

Pledged Asset Mortgage

Pledged asset mortgages allow borrowers to reduce the amount of down payment and avoid paying monthly private mortgage insurance. Here’s how it works.

A traditional mortgage requires a borrower to provide a down payment of at least 20% of the house’s price. The house itself will serve as collateral. If a borrower provides a lower down payment, it will face higher interest rates along with private mortgage insurance payments on a monthly basis.

A pledged asset mortgage allows borrowers not to make the required down payment. Instead, a borrower provides additional collateral with the corresponding value. For example, if you own a car that costs nearly 20% of your house or have the needed amount in stocks, you can use it to qualify for a mortgage. This way, you can access favorable loan terms without paying anything upfront.

Share-Savings Loans

A share-saving loan is a financing option that allows you to borrow money by using your savings account balance as collateral. These loans are often used to build or improve credit as they are available to borrowers with bad or no credit history.

When a borrower gets a share-secured loan, the lender freezes the equivalent amount in their savings account. If a borrower defaults on a loan, a lender has the legal right to repossess the amount of outstanding debt.

Pledged Loans vs. Unsecured Loans

Both pledged and unsecured loans have their pros and cons. None of them is better as they serve different purposes and aim to help different groups of borrowers.

If you have good credit and a high income and need an amount of up to $100,000 for your personal needs, you can turn to unsecured loans. Borrowers with bad credit and below-average income who want to get a lower interest rate can benefit from a secured loan. Additionally, pledged asset loans can help borrowers with good credit ratings reduce a mortgage down payment or get more extended repayment terms.

Are Pledged Asset Loans Risky?

Pledged asset loans always come with financial risks. Although a borrower retains ownership of the asset they provide as a pledge, they can lose it in case of default. Therefore, it’s recommended to be realistic about your financial situation and ability to repay the loan before getting one.

Alternatives to Pledged Asset Loans

If you need money for your personal needs but don’t want to provide collateral, consider the following alternatives to pledged asset loans.

Unsecured Personal Loans

An unsecured loan is a loan offered by a traditional financial institution or online lender. This loan requires a borrower to have good credit and always comes with a hard credit report check. Eligible customers can access up to $100,000 and repay the funds in equal monthly installments within up to 60 months. An unsecured loan can be a great option for high-income borrowers with no credit issues.

Bad Credit Loans

A bad credit loan is a high-interest loan that can be used to cover urgent needs. This loan is known for being fast, convenient, and easy to get. Most bad credit loans are available online and can be transferred within one business day. As the name suggests, they come with no minimum credit score requirements and involve no hard credit inquiries. However, an interest rate will be much higher compared to traditional options.

Joint Loans

A joint loan allows bad credit borrowers to qualify for unsecured loans and get lower interest rates without providing collateral. Instead, an applicant needs to bring a co-signer. A co-signer is an individual, for example, your friend or family member, who has good credit and a stable income. However, joint loans carry some risks to co-signers. If a borrower defaults, a co-signer will be responsible for repaying the loan.