FIRE: How do cash-secured loans work?
Explaining a better way to borrow during FIRE.
Cash secured loans are low rate borrowings that use your savings as temporary collateral.
This type of lending is perfect for anyone currently saving for short to medium-term goals while they are in debt.
So essentially anyone with student loans and home loans (which is almost all of us).
Let's walk through a quick example/story.
John and Sarah are newlyweds saving up for a new home purchase within the next few years and both have student loans.
Just like any smart couple, they have an emergency fund.
But they also are putting aside money each month so they can afford the downpayment on their home.
After a year, they have saved $5,000.
The happy couple currently has $20,000 worth of Parent Plus Loans (student debt) and an interest rate of 7.5%.
They cannot refinance the debt into their own name because they would lose the Federal protections & the debt would then show up on their credit report (making it harder to get a home loan).
So instead of refinancing, the happy couple uses a cash-secured loan.
John and Sarah use the $5,000 they have saved for the downpayment as collateral for the loan.
The loan rate they get is WAY below their current Parent Plus Loan rate - at only 3%!
Over the course of the next 12 months, the happy couple save 4.5% in interest or, stated differently -
$225 in interest payments.
These payments would have fattened the pocket of a banker before. Now they pay for that extra night in paradise or couples massage you've been dreaming of.
At the end of the 12 months, John and Sarah also get their original $5,000 back.
To note, John & Sarah did pay a little extra towards their loans throughout the year compared with before. This was because they were paying off the LOAN and not the interest.
So they've actually forced themselves pay off their loans more quickly, to earn an extra $225, and to take a step closer to the debt free life.
So in the end of the day, this was a smart move.
The classic counter argument?
Why not just take the $5,000 in savings for the down payment and throw it all towards the student loans?
Not a bad move and if that's what you want, go for it.
Cash secured loans are simply a different option that aligns with your long term financial planning & personal savings habits.
By using cash-secured loans, you can continue to save for your short to medium term financial goals, keep the money in your bank account, and simply reduce the interest rate you are paying on your loans.
At the same time.
The only difference between paying the loan entirely upfront is that you will save a little bit more in interest expense but then may feel cash poor/not have access to needed savings when you need them.
Either way - start chasing debt freedom!