What Is A Pledge Loan?

Getting your head around different types of loans and financial assistance available can be a challenge, especially if you are not well versed in the world of financial literacy, investments, and savings.

What Is A Pledge Loan

The idea of a “pledge loan” is one that is perhaps less well known and understood than other types of loans and financial arrangements, and so you may not be familiar with the details.

Whether you are keen to secure finance, curious about the details of a pledge loan, or simply want to learn more about the financial options available, we have everything you need to know.

What Is A Pledge Loan?

The first and most obvious, question is what exactly is a pledge loan? In the simplest terms, a pledge loan, also known as a pledged asset, is a promise to pay back a loan using a particular asset.

In other words, an asset or possession that holds value will be transferred to a financial lender and used to secure a loan or a debt.

In this sense, a pledged asset can be used as collateral by the lender – they hold your item as reassurance that you will be able to pay the money back, and in return, offer you a specific loan.

Pledging an asset can mean that you are more likely to be accepted for a loan, especially for higher amounts, as you have collateral that the lender can fall back on – this reduces the risk on their end.

In some cases, the “pledged asset” may also be used as the down payment for a particular loan, meaning that you are not required to find vast sums of cash upfront – you can simply use the pledged asset to secure your financial assistance.

This can also help to reduce the amount of interest that you are charged for the life of the loan, as the loan is then considered to be “secured” rather than “unsecured”, and help you to negotiate more favorable repayment terms and conditions.

Common examples of pledged assets include stocks, bonds, equity, and, in some cases, cash.

It should be noted that while the asset is pledged to the lender, the borrower will still be the legal owner of the asset.

They may continue to earn any capital gains, dividends, or interest that is gathered on the assets for the duration of the loan.

Once the loan has been repaid in full and the outstanding debt is considered to be settled, the asset will be transferred back to the borrower.

If, however, the borrower then defaults on the loan, the lender will have the legal right and recourse to seize ownership of the asset that has been pledged.

Pledged-Asset Mortgages

For many of us, our mortgage is one of the largest and most important loans that we will take out over the course of our lives – our homes depend on them.

Obtaining a good deal on a mortgage can be tricky, however, especially when we consider the ever-changing property market, rocky economy, and changing financial landscape.

Pledged-Asset Mortgages

In some cases, a new homeowner will be able to pledge assets and securities to the lending institution providing the mortgage, and this can be in lieu of a hefty down payment.

This is often the biggest stumbling block for individuals wishing to buy a new home.

In many traditional mortgages, this asset will be the property that you are purchasing, but many banks and financial lenders will also require a 20% down payment, in addition to monthly private mortgage insurance.

No down payment will also usually mean a higher interest rate, and this can drive up your monthly repayments.

Offering a pledged asset can cover the necessary down payment, and can also lower your interest rate and help to reduce private mortgage insurance payments.

As an example, a buyer may wish to purchase a house worth $200,000, and so needs a $20,000 down payment. They may be able to use the $20,000 they have in investments to pledge to the bank in lieu of the down payment.

As with any pledge loan, the borrower will still be the legal owner of the asset, and any capital gains or interest accrued will still go to them.

Remember, however, that if the buyer defaults on the mortgage, the bank will be entitled to seize the pledged asset.

A pledged-asset mortgage may be recommended by financial institutions to a buyer with the necessary assets – be that cash or investments – available and to hand, and who are not keen on selling these investments to meet the requirements of their down payment.

When you sell investments, you are usually obligated to pay significant tax returns to the IRS, and selling a lump sum – such as an investment – can raise the annual income of the seller, moving them to a higher annual tax bracket, and requiring a greater tax payment.

In many cases, this can negate any financial benefits enjoyed from the investment itself.

A pledged-asset mortgage, therefore, offers the best of both worlds. Borrowers can retain their investments, as well as benefit from interest, growth, or capital gains, and avoid heavy tax penalties from the IRS.

At the same time, they will not need to worry about finding their deposit or down payment for a new property.

Pledged assets can also be used to help out a family member who may be struggling to find the down payment for a house.

In these situations, you may be able to pledge your assets to help them get a mortgage, and cover their down payment.

Will I Qualify For A Pledge Loan?

In most cases, qualifying for a pledge loan or pledged-asset mortgage will require the borrower to prove that they have investments or assets valued at a higher amount than that required for the down payment.

In some cases, the borrower may pledge an asset to secure the loan, only to find that the value of the item decreases – this can be common in a property.

Will I Qualify For A Pledge Loan

If this occurs, then the borrower may be obligated to find the additional funds to top up the asset to the agreed value.

It should also be noted that some banks and financial institutions will not accept certain types of investments, particularly those that they may consider to be risky to the bank – options and derivatives are typically excluded.

Any assets in a 401 (k), retirement fund, or IRA will also be ineligible.

What Are The Pros and Cons Of A Pledge Loan?

As with any financial decision, a pledge loan comes with its own pros and cons, and these include:

Pros

  • The borrower will retain ownership of the asset that they pledge for the loan and will be able to continue to benefit from growth, capital gains, or interest.
  • Tax penalties and capital gains taxes can be avoided by the borrower, as they are not required to sell their investment or asset.
  • A pledge loan enables borrowers to access larger loans and mortgages without the need for a high down payment.
  • With a pledged-asset mortgage, private mortgage insurance payments can be avoided.
  • Investments can continue to grow, providing the borrower with an income
  • A lower interest rate can be enjoyed on the mortgage or loan

Cons

  • Lenders may demand that a specific type and quality of investment or asset are provided – they will usually avoid anything considered to be “risky”.
  • Now all investments are eligible to be used as a pledged asset.
  • The borrower may find themselves limited in the actions that they can take with the pledged assets – stocks cannot be included in a risky trade, for example.
  • With a pledged-asset mortgage, the borrower is at risk of losing their home if they default on the mortgage payments. They also risk losing the securities or assets that they have pledged, as ownership can be transferred back to the bank or financial institution.
  • Additional funds may be required if your asset loses value over the life of the loan
  • You may pledge assets for a family member, but this carries extra risk, as you have no way of knowing whether they will meet their repayment obligations.
  • Because no down payment is made, borrowers will need to pay loan interest on the full price of a property being purchased.

Final Thoughts

A pledge loan can be a great way to help you obtain the financial support, assistance, or mortgage that you need, without the requirement of a heavy down payment – this is typically one of the biggest obstacles, especially for new and aspiring homeowners.

It should be noted, however, that this type of loan is not without risk, and can come with some strict requirements in order to become eligible.

As with any financial decision, it is a good idea to contact an expert to discuss your options – they will be able to analyze your assets and offer advice on the suitability of a pledge loan for your unique circumstances.

They will also be able to help you proceed, and hopefully secure your new dream home in no time!

Brad Johnson