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Ask Dr. Don
Bankrate.com

CD loans

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?
Cynthia Collateral

Dear Cynthia,
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 over time.

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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.

This Bankrate 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

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