Money Matters

I am looking to purchase a vehicle. There's an alternative method to finance through a savings-secured loan (Pledge Loan) through Navy Federal. Can you explain the pros/cons of this option and if its worth considering given the high auto interest rates.

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Thanks Kelsy! This is an excellent question.

I looked up the savings-secured loan through Navy Federal, and if I found the right product, I can see why you’re intrigued (link and snip below to confirm). I haven't previously done much research on this specific type of product, so it was fun to learn and think it through.

Quick disclaimer: my reply does not represent professional financial advice, and we are not engaged in a service agreement of any kind. Simply put, I’m here as a friend 😊

Savings-secured loan vs. traditional auto loan

Without more specific details of the product, based on Navy Federal's site I generally expect the pledge loan would be both cheaper and more flexible for you compared to a traditional auto loan. Some folks even use pledge loans as a preferred credit building tool. For example, I read about people taking a pledge loan, immediately paying most of it back, and adjusting their installment payment amount to pay tiny amounts for the rest of the term. While any loan will likely decrease credit scores initially (the inquiry and the increase in total debt amount are both negatives) the users mitigated this by paying back most of the debt immediately and then expanded their positive credit history by paying their installment loan timely. That may not be an option with all products, but sharing in case it's helpful to consider.

I think the risks are likely similar between savings-secured and a traditional auto loan, since both are collateralized (pledge loan secured by your cash, auto loan secured by your car). As a conceptual note, I think the reason they can offer a lower rate for a pledge loan is because the cash collateral is better compared to a vehicle, which depreciates with time and usage. However, it would be good to make sure you understand what would happen in the event of missed payment or default, and if there are any penalties for early repayment if you decide to do so. Then you can compare that to what you know about traditional auto loans.

As long as there's nothing too sinister in the savings-secured loan fine print, it seems like a valid alternative to a traditional auto loan and may be cheaper and/or more flexible. 

Savings-secured loan vs. cash

It sounds like you already have cash that you'd be using to secure/collateralize the loan, so that leads to the question – why not just use the cash for your purchase? Why pay interest if you don’t have to? Really, that comes down to personal preference and opportunity costs. Full transparency - I've never used a pledge loan, so I don't want to assume I know every nuance, but I think I understand it enough to form a general opinion. 

For any given person, I suspect the material opportunity costs of using your existing cash to pay for the vehicle up front instead of using it to secure a loan are:

1.      Lost flexibility. You'd save on the interest costs of the loan, but your cash would be gone-gone. However, make sure you understand when/how your cash would become available to you again as the pledge loan is repaid. Some folks may decide that the cost of the interest is worth the flexibility, compared to the finality of sending all the cash out the door at once. This comes down to personal preference, as well as reasonably projecting other life/cash needs over the term of the loan. Again though - most important is to understand when/how cash becomes available under the savings-secured loan, so that you can reasonably compare your liquidity. 

2.      Lost credit-building opportunity. Using a loan of some kind provides credit-building if needed/desired; however, depending on severity of the need or desire to build installment credit, this may not be worthwhile.

Hope that helps, and thanks again! 

P.S. this is the product I found and was reviewing. 

Thanks!

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