CD Loans Explained

Most CDs have a fixed period, and if you need the money before then, you’ll have to withdraw it early from the credit union or bank and face a penalty. However, you can avoid this by taking out a loan against your CD at the bank. That money is repaid to you over time, plus interest. You now have not one but two CD accounts running concurrently (the original CD as well as this new CD loan).

Even while CD loans are not as widespread as some other kinds of personal loans, they can nonetheless provide much-needed emergency funds and aid in the establishment or restoration of credit. Before taking out a CD loan, it’s important to weigh the pros and cons.

What Is a CD Loan?

A CD loan is a specialized form of savings account that can be opened with financial institutions including credit unions and banks. Its value increases over a predetermined length of time, which can range anywhere from three months to fifty years. However, in contrast to a standard savings account, you won’t be able to access your money during the term that you choose, which transforms a certificate of deposit into a vehicle that is better suited for long-term savings than one that is intended for short-term profits.

When you purchase a CD with a duration of three years, the money that you deposit into the account must remain there for the entirety of that term. After a period of three years, the certificate of deposit will become fully mature. You have the option to either take the money out of the CD or renew it for another term so that you can keep earning interest. Once the CD has reached its maturity, you will normally have between five and ten days to determine how to proceed. If you fail to tell the credit union or bank of your plans regarding the CD, it is possible that it will be automatically renewed.

How Do CD Loans Work?

A CD loan is a type of secured personal loan, with the CD’s value serving as collateral. A CD secured loan allows you to borrow from the bank using the value of your CD as collateral. If you default on your loan payments, the bank can confiscate the funds from your CD as repayment.

A CD loan functions similarly to other personal loans in that you borrow money and pay it back over a set period of time (in this case, monthly), but the interest you pay back will far outweigh the income you earn on the loan. However, the length of the loan depends on when your CD will mature, or the day on which you will no longer be charged a penalty for withdrawing funds before they are actually needed. If your CD has a 12-month maturity date, for instance, the maximum length of your loan would also be 12 months.

Personal loans backed by CD funds are preferred by financial institutions because of the lower risk they pose. The interest rate on your loan is based on the annual percentage yield (APY) of your CD, which is a measure of the amount of money you earn each year. Your bank will likely add an additional 2% or 3% to your APY. The rate you obtain, however, will be determined by your credit score.

Let’s say your CD’s APY is 1%, and the bank adds 3% to that rate for determining the interest rate on CD loans. Your CD borrowing rate would therefore be 4% (1% plus 3%). Although you won’t be able to access your CD money during the period of repaying the loan, you will still earn the APY on your CD and it will still mature. In the same vein, in this case, you would gain 1% by borrowing the money.

You may utilize the funds on your CD loan as you like. For example, you may utilize the funds to settle high-interest debt, cover unexpected costs, or finance a home improvement project. You might not be able to put it toward a mortgage or college tuition, though. You should verify the permitted uses and any applicable restrictions with your bank.

CD Loans: Pros and Cons

Loans backed by CDs can be helpful in certain situations, but they aren’t for everyone. Some of the pro and cons are shown below.

Pros

• Lower the rates of interest. CD loans provide lower interest rates than credit cards, payday loans, and other sources of borrowing. This is due to the fact that lenders see less of a risk in lending against funds already on deposit.

• Regular and secure payments. When you get a CD loan, your monthly payments will be set in stone, so you know exactly how much money you’ll owe and when it’ll be due.

• May help your credit rating. If you want to improve your credit but have been turned down for a credit card or other loan, a CD loan might be your best option. Lenders typically report customer payment history to the three major credit reporting agencies.

Cons

• CD required. If you do not possess a CD or are unwilling to open one, you won’t be able to get a loan secured by a CD.

• Not available everywhere. It’s possible that your local credit union or bank doesn’t provide CD-secured loans. The likes of Chase as well as Bank of America are too big to offer the types of funding we’re discussing here.

• Borrower-guaranteed investment in CDs. With a CD as collateral for a loan, you won’t have access to the money until the loan is paid back.

Are CD Loans a Good Option?

If you already possess a certificate of deposit with your financial institution, applying for a CD loan should not be too difficult. Despite the fact that they provide CD accounts, several of the nation’s largest banks do not provide access to these types of loans. It’s possible that you’ll have an easier time obtaining a loan against a CD if you go through a credit union or a community or regional bank.

Before you commit to getting a savings-secured loan against your CDs, you should first determine whether or not cashing out your CDs is a more financially prudent choice.

When Does a CD Loan Make Sense?

A CD loan can be a good choice for you if you have poor credit, need to cover unexpected costs, or don’t want to be penalized for withdrawing money too soon from your CD. However, since the funds in your account serve as collateral for the loan, the bank has the legal right to take possession of those funds if you are unable to fulfill your obligation to repay the loan.

Alternatives to CD Loans

Consider the following alternative means of gaining access to necessary finances if you do not wish to put the money on your CD at risk of being confiscated in the event that you are unable to repay the loan.

1. Unsecured Personal Loan – An unsecured personal loan, in contrast to a secured personal loan, does not necessitate the provision of any collateral. The possibility of having to pay higher interest rates is one of the drawbacks of selecting this alternative. Lenders demand that potential borrowers have a credit score that is good to excellent in order to qualify for the best rates (at least 670). Personal loans are available with credit ceilings ranging from $250 to $100,000 plus repayment lengths that can range anywhere from 2 to 7 years.

2. Secured Credit Card – A secured credit card is an option worth considering if you want to build or increase your credit score. The amount of your credit limit on a secured credit card is directly proportional to the amount of cash you deposit and have held in a collateral account. In a manner analogous to a CD loan, the bank has the right to seize your cash deposit if you are unable to repay your debt.

3. Credit Cards With 0% Annual Percentage Rate – If you possess good to exceptional credit, getting a credit card with a 0% interest rate could be one option for you to avoid paying any interest costs at all. In most cases, these credit cards provide up to 21 months of interest-free financing on balance transfers and new purchases combined. You will not be required to pay interest on the debt as long as you repay it before the end of the promotional period during which there is no interest charged. After the end of the promotional period, interest will be charged on any outstanding sums that have not been paid in full.

Final Thoughts

A CD loan may be an alternative worth considering if you already own a CD but require access to cash in a hurry. If you handle the debt responsibly, it can assist improve your credit health, and the cash that you have in your CD will keep rising even while you make payments on the loan. This is a readily accessible debt product. Because the potential for the expense of borrowing to outweigh the advantages of obtaining a loan, it is possible that early withdrawals from a CD would be the more prudent choice. However, these loans do have their negatives.

Find out more about the CD loan possibilities that might be open to you by consulting with your local bank or credit union. It is equally crucial to inquire about the terms of the loan in order to assess if you should proceed with the application process or whether you should look into other options.