||Ask Dr. Don
Dear Dr. Don,
Both my husband and I are about to get a large tax refund.
My husband wants to take $10,000, put it in a savings
account and borrow against it. We owe some of this amount to family,
but we also owe other debts with interest rates ranging from 11
percent to 24 percent .
State Bank, a local bank in my town, will let us put
our $10,000 in a savings account, which would make only 1.25 percent
interest. But if we borrow against our savings, the interest rate
would be 3.25 percent. Do you think this is a wise thing to do?
One advantage would be that the loan would be in my
husband's name, and he is trying to improve his credit status from
a previous marriage. My husband wants to do this so we will have
money in the bank after paying our debts.
Is this a wise decision?
Borrowing against money held in a CD or savings account can make
sense, especially if your husband is trying to rebuild his credit
history. He needs to make sure that the bank is going to report
the payment history to one of the three major credit bureaus.
As you've discovered, the financial institution typically
charges you a premium over what you're earning on the CD. Make sure
you understand how both the savings rate and the loan rate can change
Since the principal reason he's taking out this CD
loan is to rebuild his credit history, make sure that the repayment
schedule fits into your monthly budget, and review any grace periods
or renewal options. It would be a shame to get the loan as a credit-building
exercise and then wind up adding late payments to his credit history.
A second reason to take this approach is the forced-savings
aspect of the loan. You've traded higher-cost debt for this low-cost
debt, reducing the interest expense. While it's true that you could
have just used the money to pay off the debts reducing the interest
expense to zero, making the required payments to the bank will force
you to rebuild the savings account. This is a good approach for
people that don't have the discipline to fund savings as an item
in their household budget.
feature discusses CD loans in greater depth and links to a list
of items to consider when shopping for a CD or savings account loan.
Shop rates at several financial institutions before applying for
the loan. If you belong to a credit union, that would be a good
place to start shopping.
-- Posted: April 18, 2002