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In a pinch, they can re-establish shaky
credit history and put borrowers on good footing with mortgage
and car loan lenders. In good times, they can provide the
cash for once-in-a-lifetime vacations, weddings or that snazzy
piece of jewelry.
Certificate of deposit loans and CD lines
of credit are quietly becoming the other white meat of loan
products for some mid-sized and small community banks.
Here's how they work:
- A simple certificate of deposit allows
the owner to deposit a certain amount of money, (at the
minimum, $500) as an investment for a fixed length of time,
ranging from three months to five years. CDs are federally
insured and pay higher rates of return than simple savings
accounts.
- The depositor can take out a loan for
up to 100 percent of the CD amount, secured by the CD itself.
Because the loan is secured by the cash in the account,
the interest rate to the borrower is low -- typically the
annual percentage rate of the CD plus some index the bank
uses.
- The loan is paid back during the term
of the CD, which can be up to five years. If the customer
defaults on the loan, the bank can seize the money invested
in the CD. If the loan is not repaid by the time the CD
expires, the depositor can renew the CD to extend and refinance
the loan.
- Rates vary, but typically, the borrower
will pay a premium of several percentage rates to borrow
their own money. In other words, if the CD is paying 6 percent,
for example, the cost of borrowing might be 9 percent.
"A
better way to borrow"
"It's a much better way to borrow money
than going into unsecured debt or borrowing money against
your home," said Steve Rhode, president of Debt
Counselors of America.
The benefits of this loan are that it
typically carries a low interest rate compared to an unsecured
personal loan or credit card, and it allows savings to remain
in place. Most of the time the CD continues to earn interest
on a monthly or yearly basis, offsetting the interest charged
on the loan so that, in many cases, the borrower is paying
an even lower rate of interest. Depending on the bank, it
may affect the outcome of the interest rate on the loan.
For example, Joe Account Holder has a
$1,000 CD. He wants to take out a personal loan against the
CD to pay for car repairs. His bank will draw up a loan agreement
that spells out the terms, interest rate and when the loan
has to be paid off.
For
once-in-a-lifetime sprees
Some community banks tout CD loans as the first steps
to establishing credit or repairing a shaky credit history
-- especially compared with the high interest rates borrowers
would pay for a secured credit card or sub-prime auto loan
and because of the more flexible repayment terms of a CD loan.
But CD loans also can help out at the
other end of the scale, too. At Guaranty
Federal Bank in Dallas, CD holders typically secure loans
for big-money events such as "once-in-a lifetime vacations,
buying a dream car or funding a wedding," says Bob Butler,
senior vice president and director of consumer lending.
Guaranty Federal offers both CD loans
and a CD line of credit that lets borrowers write checks against
the line.
More
flexible payment schedule
"People like this arrangement because they don't like
having to make ongoing, regular payments," Butler said.
"When someone borrows money today, they normally have
to go through a lot of hassles, wait on credit reports. If
someone has a CD, it should take no more than five or 10 minutes
to get a loan approved."
Another mid-sized Texas bank, Frost
National Bank, also offers loans through its CDs. Deposit
holders at the San Antonio-based bank often are establishing
credit history. Some are looking to buy home appliances, electronic
equipment and other consumer products with the loan, explains
Charles Mella, senior vice president. And for others, the
loan "postpones the inevitability of a monthly payment,"
Mella adds.
CD customers at Horizon
Bank are eligible to borrow as much as 90 percent of their
deposits. The interest rate is 3 percent more than the annual
percentage rate of the CD. As with most secured loans, if
the customer doesn't repay the loan by the end of the CD term,
he can renew the certificate and rewrite the loan.
An
open-ended loan
"The beauty is they can have the loan for
as long as they have the CD," said Marjorie LaValley,
consumer loan manger of the Bellingham, Wash.-based bank.
LaValley said the approval process takes roughly 30 minutes.
Establishing
credit history
Despite their low interest rates and generous repayment
terms, consumer finance counselors advise borrowers to ask
if the bank reports loan payments to any of the three credit
agencies. If the bank reports loan activity, it can work in
the borrower's favor if payments are made on time. Likewise,
if the borrower defaults on the loan, that activity is also
reported. Otherwise, it's a waste of time for borrowers looking
establish a credit history if the bank doesn't report any
payment activity.
"The times when people get into financial
trouble is when they get in over their head through overspending,"
said Rhode of Debt Counselors. "With these loans, you
still have the money."
-- Posted: Nov. 13, 1998
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