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What Is A CD Loan?
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What Is A CD Loan?

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What Is A CD Loan?

If you own a certificate of deposit (CD) account and need to borrow money, a CD loan can be a good option. A CD loan typically comes with a lower interest rate than other loans, is easy to qualify for if you don’t have stellar credit and is drawn against your CD account. While it’s a handy way to borrow money, it does come with its own risks and there is a limit to how much you can borrow.

How a CD Loan Works

A CD loan is a secured personal loan—the funds in your CD back and secure the loan. When you take out a CD secured loan, your bank lets you borrow against the money in the account. If you fail to repay the loan, the bank can seize the money in your CD, because that’s what you pledge as collateral.

Similar to how most personal loans work, a CD loan has a fixed interest rate, which will more than eclipse the interest you’re earning in the first place, and you repay the loan in fixed monthly installments. The loan’s term, however, is based on your CD’s maturity date—the date you can access money in the account without incurring an early withdrawal penalty. For example, if your CD matures in 12 months, then the maximum term for the loan would be 12 months.

Since this type of personal loan is secured by the money in your CD, it is considered less risky for banks. The bank uses your CD’s annual percentage yield (APY), which measures the amount of interest you earn yearly, to calculate the loan’s interest rate. Banks typically add a minimum of 2% to 3% of interest on top of your APY. However, the rate you receive will vary based on your credit.

For example, let’s say your CD has an APY of 1% and the bank calculates CD loan rates by adding 3% above that rate. That would mean your CD loan rate is 4% (1% + 3%). Although your CD funds are put on hold while you repay the loan, you’ll still be able to earn your accounts APY, and your account will still mature. So, using the same example, you’d earn 1% while borrowing the money.

There typically aren’t many restrictions on how you can use the money from a CD loan. You could use the money to consolidate high-interest debt, pay for emergency expenses or finance a home remodeling project. However, you may not be able to use it for educational purposes or to purchase a home. Check with your bank to confirm its specific use cases and restrictions, if any.

Who Is a CD Loan Right For?

CD loans are right for people who need funds to pay for emergency expenses or those who want to establish or build credit. Because CD secured loans require collateral, it’s easier for fair-credit or no-credit borrowers to qualify. If the loan is repaid on time, it can help you improve your credit score.

Additionally, CD loans are right for people who want to avoid paying an early withdrawal penalty for removing funds from their account too early. If that’s you, calculate how much you’d spend in withdrawal fees versus the cost of the loan.

How to Get a CD Loan

  1. Apply for your loan: Apply online or in person with the bank where the CD account is located. When you apply, you’ll have to provide personal contact and employment information.
  2. Select your terms: Choose your desired loan term and the amount you need to borrow. Keep in mind that you can’t borrow more than what’s in your account, and your maximum term length is typically equal to your CD’s maturity date. Some banks, however, may require your loan to be shorter than your CD’s term and cap the loan amount at a certain percentage of your account’s funds.
  3. Wait for an approval: Once you apply, you’ll have to wait for the bank to decide whether to lend you the money. Depending on your financial circumstances, this can take as little as five minutes or much longer.
  4. Sign your loan agreement and receive your funds: Once approved, the lender will send you a loan agreement to sign. You can sign the agreement after you’ve read through it and move forward with receiving your funds.
  5. Repay your loan: The final step of the loan process is to repay your debt in monthly installments. Typically, the longer your loan term, the lower your monthly payment. However, that means you’ll pay more interest over time.

Alternatives to a CD Loan

If you don’t want to risk losing the money in your CD for failure to repay the loan, consider these alternative options for accessing necessary funds.

Unsecured Personal Loan

Unlike a secured personal loan, an unsecured personal loan doesn’t require any collateral. The downside to this option is that you’ll most likely have higher interest rates. To get the best rate, lenders require applicants to have a good to excellent credit score (at least 670). You can get personal loans with limits between $250 to $100,000 and repayment terms from two to seven years.

Secured Credit Card

If you need to establish or improve your credit, a secured credit card can be a good alternative. Secured credit cards have credit limits that are equal to a cash deposit you make that’s held in a collateral account. Similar to a CD loan, if you fail to repay your debt, the bank can seize your cash deposit.

0% APR Credit Card

If you have good to excellent credit, one way to avoid interest fees altogether is through a 0% APR credit card. These cards typically offer no-interest financing on purchases or balance transfers for up to 21 months. As long as you pay the balance off before the interest-free promotion period expires, you won’t be responsible for paying interest. Once the promotional period expires, any unpaid balances will begin to accrue interest.

Pros of a CD Loan

  • Lower interest rates compared to other products
  • Fewer qualification requirements, meaning they’re good for borrowers with low credit scores
  • You can avoid an early withdrawal penalty
  • The money in your CD continues to earn interest even when you’re repaying the loan

Cons of a CD Loan

  • You’re limited to borrowing the amount you have in your CD
  • If you default on your CD loan, the bank can take the money from your CD
  • Some lenders charge origination fees, which increases the cost of borrowing and reduces the amount of the loan

Frequently Asked Questions (FAQs)

Does a CD loan build credit?

If you pay your CD loan back as promised, it can help you build credit. Payment history is a key factor that makes up your credit score, accounting for 35%. This means if you default on your loan, it can have a negative impact on your credit score. Be sure you set up a repayment plan before taking any money out.

Are CD secured loans a good idea?

If you need to cover an emergency expense, have damaged credit or don’t want to get hit with an early withdrawal fee, a CD loan could be a viable option. However, because the money in your account backs the loan, if you fail to repay your debt, the bank can repossess the funds in your account.

How long will it take to get the funds once my CD loan is approved?

The length of time varies according to the bank, but after you’re approved, some banks will issue your funds the next business day.

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