How does a passbook loan work?
A passbook loan is simply a loan using a deposit account as security for a loan. It can be used to establish credit, re-establish positive credit or provide funds when the borrower chooses not to liquidate a deposit account for a purchase.
The rate of interest is usually a couple of points above the rate of interest paid on the deposit and the use of those funds is frozen till the loan is paid off. Most lenders will only allow 90-95% of the balance of the account for loan proceeds. The logic here is that if the consumer doesn't make scheduled payments, the account balance can be used. It is important to let these loans run for 12 months or more if establishing or re-establishing credit is the goal. The difference in interest paid is minimal compared to the benefit gained by credit reporting on the loan.