how pledged assets work
the borrower will transfer the title of a pledged asset to the lender but the borrower will still maintain ownership and use of the valuable possession should the borrower default the lender has legal recourse to take ownership of the asset pledged the borrower retains all dividends or other earnings from the asset during the time it is pledged some loans contain a negative pledge clause or covenant that limits the borrower from using the pledged asset to secure other loans the asset is merely collateral for the lender in the event of borrower default however for the borrower the pledged asset could help considerably with gaining approval for the loan assets can include cash stocks bonds and other equity or securities 1using the asset to secure the note may let the borrower demand a lower interest rate on the note than they would have had with an unsecured loan typically pledged asset loans provide borrowers with better interest rates than unsecured loans 2once the loan is paid off and the debt is fully satisfied the lender transfers the pledged asset back to the borrower the type and value of pledged assets for a loan are usually negotiated between the lender and borrower pledged asset mortgagehomebuyers can sometimes pledge assets such as securities to lending institutions to reduce or eliminate the necessary down payment with a traditional mortgage the house itself is the collateral for the loan however banks usually require a 20 down payment of the value of the note so that buyers do not end up owing more than their home s value 3also without the 20 down payment the buyer must pay a monthly insurance payment for private mortgage insurance pmi without a significant down payment the borrower will likely also have a higher interest rate 4the pledged asset can be used to eliminate the down payment avoid pmi payments and secure a lower interest rate for example let s say a borrower is looking to buy a 200 000 house which requires a 20 000 down payment if the borrower has 20 000 in stocks or investments they can be pledged to the bank in exchange for the down payment the borrower retains ownership of the assets and continues to earn and report interest or capital gains on those assets however the bank would be able to seize the assets if the borrower defaulted on the mortgage the borrower continues to earn capital appreciation on the pledged assets and gets a no down payment mortgage using investments for a pledged asset mortgagea pledged asset mortgage is recommended for borrowers that have the cash or investments available and don t want to sell their investments to pay for the down payment selling the investments might trigger tax obligations to the irs the sale may push the borrower s annual income to a higher tax bracket resulting in an increase in their taxes owed typically high income borrowers are ideal candidates for pledged asset mortgages however pledge assets can also be used for another family member to help with the down payment and mortgage approval qualifying for a pledged asset mortgageto qualify for a pledged asset mortgage the borrower usually needs to have investments that have a higher value than the amount of down payment if a borrower pledges security and the value of the security decreases the bank may require additional funds from the borrower to make up for the decline in the asset s value although the borrower retains discretion as to how the pledged funds are invested the bank may impose restrictions to ensure the pledged assets are not invested in financial instruments that are deemed risky by the bank such risky investments may include options or derivatives further assets in an individual retirement account ira 401 k or other retirement accounts cannot be pledged as assets for a loan or mortgage pros and cons of a pledged asset loan or mortgagethe use of pledged assets to secure a note has several advantages for the borrower however the lender will demand a specific type and quality of investments before they will consider underwriting the loan also the borrower is limited to the actions they may take with the pledged securities in dire situations if the borrower defaults they will lose the pledged securities as well as the home they purchased the borrower must continue to report and pay taxes on any earnings they receive from the pledged assets however since they were not required to sell their portfolio holdings to make the down payment it will not place them into a higher tax income bracket a pledged asset loan allows the borrower to retain ownership of the valuable possession borrower avoids tax penalties or capital gains taxes from selling the assetspledging assets avoids large loan down payments and pmi if applicable the borrower may receive a lower interest rate on the loan or mortgage the borrower continues to earn income and must report the gains from their investments the ability to trade the pledged securities might be limited if the investments are stocks or mutual funds the borrower could lose both the home and the securities in the event of default by not making a down payment loan interest is paid on the full price of the property if the pledged securities decline in value the lender may demand additional funds pledging assets for the loans of a relative carries default risk since there is no control over the borrower s repayment who owns pledged collateral if you pledge your assets as collateral for a loan you will still own the pledged collateral if you fail to make payments according to the terms of the loan the lender could seize the collateral and you would no longer own it at that time 5can i use a car as collateral for a loan you can use a car as collateral for some personal loans you must have equity in the car or value that is paid off if you have trouble getting a personal loan due to bad credit you may consider using your card as collateral however if you cannot make the payments the lender will be able to repossess your car to pay off the loan 