You’ve probably heard of certificates of deposit (CD) — but have you ever heard of a CD loan? While CDs are traditionally a savings tool, they can also be helpful when borrowing money. Some banks and credit unions allow you to borrow money against a CD that you already own, in the form of a secured loan.
“CD loans aren’t very common,” says Thomas Rindahl, financial advisor with TruWest Wealth Management Services in Phoenix. “In fact, when I talk to people, most don’t realize they are available. You’ll have to check with different financial institutions to see if they offer the service, but they can be useful for some people.”
CD loan: How does it work?
A CD loan is a loan that is secured with a certificate of deposit you already own. This type of loan allows you to borrow against the funds you have saved in a CD without having to pay early withdrawal penalties. You can use this type of loan for a variety of uses, such as debt consolidation, home improvement expenses, or medical bills.
The amount you can borrow will depend on the financial institution, but it can generally range from $500 up to $250,000. The amount you can borrow will vary. Some banks will allow you to borrow the full CD amount, while other banks cap CD loans at a percentage of the total amount in the CD. Some banks will only allow you to borrow against CDs that you have with their institution, and will not accept CDs issued by other banks as security.
These loans often have lower interest rates than those you’ll be charged with credit cards or unsecured loans. For example, at Wells Fargo the annual percentage rate (APR) for a CD-secured loan is fixed and ranges from 5.50% to 13.79%, while the APR for an unsecured personal loan ranges from 5.49% to 22.99%. CD-secured loans can also charge an origination fee.
Interest rates on CD loans tend to be lower than unsecured loans because you’re using your CD as collateral, meaning the bank can take the money in your CD if you were to default on the loan. In fact, even if you have a high debt-to-income ratio or a low credit score, you may still be approved for a CD loan.
“It’s relatively easy to qualify for a CD loan because it’s 100% secure as far as [the] financial institution is concerned,” says Rindahl. “This is a good type of loan if someone is looking to establish or reestablish credit. If the borrower makes the payment on time, they’ll have good credit reported to the credit agencies.”
Approval for the loan is often quick, with some financial institutions providing approval within hours and funding the same or next business day.
Pros and cons of CD loans
Should I get a CD loan?
If you currently have a CD and need quick cash, this type of loan can be a good option, since the application process is usually easy and the funds are often dispersed quickly. By taking out a CD loan, you can avoid having to pay a penalty for cashing in your CD before its maturity date.
These loans can also be a good choice for people who want to build their credit history or who need to rebuild their credit score after having trouble in the past. Qualifying for a CD loan is easier than qualifying for many other types of loans.
If your goal for the loan is to repair your credit history, make sure the financial institution submits your payment history to at least one of the three major credit reporting bureaus: Experian, Equifax and TransUnion. You will want to make your payments on time; if you don’t, missed payments could hurt your credit score.
Before you take out a CD loan, it can be helpful to explore whether cashing out your CD is the cheaper option. Since these loans include origination fees and interest, it might be more cost effective to cash in your CD, even if it incurs an early withdrawal penalty. The decision can depend on your CD interest rate.
For example, a 12-month $5,000 CD loan with a 5.5% APR and an origination fee of $75 would cost $225. Subtract the amount of interest you would earn from the CD during that year. If your CD has a 2.5% annual percentage yield (APY) and compounds monthly, you would realize earnings of $125 during that period of time, which means the net cost of the loan would be $100.
If you cashed out your CD instead of taking a secured loan against it, you would pay an early withdrawal penalty, which is often an amount of the interest earned. The average penalty for a 12-month CD is 120 days, or four months, of interest. If your CD pays 2.5% interest each year, you would forfeit $41.67. In this case, cashing out your CD may be the better choice.
Alternatives to CD loans
While a CD loan may be a good choice for some, there are other types of secured loans and lines of credit that help you with your money needs as well as help you build your credit.
- Home equity line of credit (HELOC): If you are a homeowner, a HELOC may be a better vehicle. The line of credit uses your home equity as collateral. You can use as much or as little as you like, depending on your needs, which may be more convenient. Still, this could be risky, as you’d lose your home if you defaulted.
- Secured credit card: If your goal is to build credit, a popular option is a secured credit card, offered by many financial institutions. You submit a deposit that becomes your credit limit and acts as collateral for the loan. “If you’re not using the line of credit, you have nothing to pay and it won’t infringe on your monthly cash flow,” adds Rindahl.
- Savings-backed loans: You can also get a loan or line of credit that is backed by your savings account. If you don’t have a CD but do have a savings account, this may be an easier option. During the time of your loan, however, you will not be able to use the funds in your savings account.