CD loans are one way to borrow money for emergencies, debt consolidation and more. If you have a certificate of deposit, you might qualify for a secured loan to get the cash you need. These types of loans often come with lower interest rates than other types of loans, although they do come with benefits and drawbacks.
What is a CD-secured loan?
A CD loan is a type of personal loan that uses your certificate of deposit to secure the loan funds. With the certificate of deposit acting as the collateral for the loan, lenders normally offer better APRs, because even if the borrower defaults on a CD loan, the lender can recoup its losses by way of the CD. However, it’s important to understand that when you back a loan with a CD, you risk losing that certificate should you fail to make payments.
How does it work?
Some type of collateral typically backs a secured loan. For example, if you take out a mortgage to buy a new house, the house serves as collateral. Car loans work the same way; the automobile for which you obtain a loan becomes the collateral to secure the debt. When a borrower defaults on a secured loan, the lender can seize the collateral to cover the outstanding debt, which is why secured loans pose lower risks for banks and credit unions.
With a CD-secured loan, your certificate of deposit acts as collateral. CD loans allow you to retain your investment and get the additional cash you need. CD-secured loans are personal loans, which means you can use the money for almost any type of expense.
Pros and cons of a CD loan
CD-secured loans aren’t right for everyone. Here are some of their biggest benefits and drawbacks.
Pros of CD loans
- When you apply for a CD loan with a bank or credit union that holds your CD, you can often get loan approval quickly, sometimes within hours, and receive funds within a day or two.
- CD loan rates are often much lower than unsecured loan rates.
- CD-secured loans often have fixed interest rates, so you’ll pay the same amount each month.
- Your CD continues to earn interest throughout the life of the loan.
- Lenders typically allow you to use funds the way you choose.
- Banks and credit unions usually offer generous terms, sometimes allowing you to repay funds for up to 10 years.
- Borrowers with poor credit often qualify for CD-secured loans.
Cons of CD loans
- Not all banks and credit unions offer CD-secured loans.
- Typically, you must already have a CD to qualify.
- Lenders may require an origination fee or prepayment fee for paying off the loan before the end of the term.
- You cannot cash out your CD until after you’ve paid off the loan.
Does a CD loan build credit?
The short answer is yes. With its low risk and low interest rate, a CD loan can offer a good route for establishing or rebuilding credit. However, using a CD-secured personal loan to improve your credit score will work only if you make the payments in full and on time. Even though the lender can seize your CD if you default, it will still report your delinquency to the credit bureaus: Experian, Equifax and TransUnion.
While establishing or improving credit are the most common reasons for taking out a CD-secured loan, keep in mind that the lender can seize your investment if you default on the loan. If that happens, you could end up losing your CD and damaging your credit, rather than improving it. Never consider a CD-secured loan if you are facing a job loss or expense that could lead to financial instability, such as a major health crisis. In those cases, using your investments might make better financial sense.
If you want to improve your credit score without paying interest, you can also accomplish your goal by getting a credit card, charging one small expense each month and paying off the balance in full and on time.
Who is a CD loan best for?
A CD loan is good for people who want to build or repair credit, especially since these types of loans typically offer lower interest rates to people with poor credit than unsecured personal loans do. It’s also a good option for people who have a solid grasp of their monthly finances, as paying off the loan each month is critical in order to avoid losing CD funds.
People with long credit histories and a good credit score will benefit the most, as these borrowers can borrow a large amount of money at a very low interest rate.
How to apply
Most banks allow you to apply for a CD loan over the phone, online or at a branch. You’ll need your personal information, financial information and desired loan details. Your rates and terms may be determined based on your financial picture, but generally you can’t borrow more than the amount you have in your CD. When you apply, your lender will likely perform a hard credit check. Once you’re approved, you could receive funds within a week.
Alternatives to CD loans
If your bank does not offer CD-secured loans, you have other options:
- Unsecured loans: Unsecured loans don’t require collateral, so you’ll need good credit to qualify, and interest rates will likely be higher than those on CD loans. Still, these loans are a good option if you don’t want to put your assets at risk.
- Savings-secured loans: With a savings-secured loan, you pledge your funds from your savings account as collateral. Like CD loans, savings-secured loans typically offer more favorable interest rates than unsecured loans. Savings-secured loans often feature fixed-rate terms, enabling you to make the same monthly payment throughout the life of the loan. Since your own funds back the loan, banks often offer same-day approval.
- Secured credit cards: If you do not need a specific amount of money and simply need to build or repair your credit, a secured credit card offers great benefits. To get one, you must make a cash deposit, which establishes the limit you can spend using the card. For instance, if you deposit $1,000, you can use the card to spend up to $1,000. Depending on the terms of the card, the lender may extend a certain credit limit over time if you establish a good credit track record.