What is a CD loan? – Councilor Forbes
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If you have a certificate of deposit (CD) account and need to borrow money, a CD loan may be a good option. A CD loan usually has a lower interest rate than other loans, is easy to get if you don’t have stellar credit, and is taken from your CD account. While this is a convenient way to borrow money, it comes with its own risks and the amount you can borrow is limited.
How a CD loan works
A CD loan is a secured personal loan – your CD funds are repaid and secure the loan. When you take out a secured CD loan, your bank allows you to borrow against the money in the account. If you fail to repay the loan, the bank may seize the money on your CD because that is what you pledged 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 earn in the first place, and you pay off the loan in fixed monthly payments. The term of the loan, however, is based on the maturity date of your CD – the date on which you can access the money in the account without incurring an early withdrawal penalty. For example, if your CD matures in 12 months, the maximum loan term will be 12 months.
Since this type of personal loan is secured by the money from your CD, it is considered less risky for banks. The bank uses the annual percentage return (APY) of your CD, which measures the amount of interest you earn each year, to calculate the loan interest rate. Banks usually add a minimum of 2% to 3% interest on top of your APY. However, the rate you will receive will vary depending on your credit.
For example, let’s say your CD has an APY of 1% and the bank calculates CD lending rates by adding 3% above that rate. This would mean that your CD loan rate is 4% (1% + 3%). Although your CD funds are put on hold while you pay off the loan, you will still be able to earn your APY accounts, and your account will still expire. So using the same example, you would earn 1% by borrowing money.
There are usually not a lot of restrictions on how you can use the money from a CD loan. You can use this money to consolidate high-interest debt, pay for emergency expenses, or finance a home improvement project. However, you may not be able to use it for educational purposes or to buy a house. Check with your bank to confirm their specific use cases and restrictions, if any.
Who is a CD loan for?
CD loans are suitable for people who need funds to pay for their emergency expenses or for those who wish to establish or develop credit. Since secured CD loans require collateral, it is easier for borrowers with fair credit or no credit to qualify. If the loan is paid off on time, it can help improve your credit score.
Additionally, CD loans are suitable for people who wish to avoid paying an early withdrawal penalty for withdrawing funds from their account too early. If this is you, calculate how much you would spend on withdrawal fees versus the cost of the loan.
How to get a CD loan
- Apply for your loan: Apply online or in person at the bank where the CD account is located. When you apply, you will be required to provide personal contact details and job information.
- Select your conditions: Choose the desired loan term and the amount to borrow. Keep in mind that you can’t borrow more than what’s in your account, and your maximum term is usually equal to your CD’s maturity date. However, some banks may require your loan to be shorter than the term of your CD and cap the loan amount at a certain percentage of the funds in your account.
- Wait for approval: Once you have applied, you will have to wait for the bank to decide whether or not to lend you the money. Depending on your financial situation, this can take as little as five minutes, or even a lot more.
- 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 reading it and continue to receive your funds.
- Repay your loan: The last step in the loan process is to pay off your debt in monthly installments. As a general rule, the longer the term of your loan, the lower your monthly payment. However, this means that you will pay more interest over time.
Alternatives to a CD loan
If you don’t want to risk losing your CD money if you default on the loan, consider these alternative options to access the necessary funds.
Unsecured personal loan
Unlike a secured personal loan, an unsecured personal loan does not require any collateral. The downside to this option is that you will most likely have higher interest rates. To get the best rate, lenders require applicants to have a good to excellent credit rating (at least 670). You can get personal loans with limits between $ 250 and $ 100,000 and repayment terms of two to seven years.
Secured credit card
If you need to build or improve your credit, a secured credit card can be a good alternative. Secured credit cards have credit limits equal to a cash deposit you make that is held in a security account. As with a CD loan, if you are unable to repay your debt, the bank may seize your cash deposit.
0% APR credit card
If you have good to excellent credit, one way to avoid interest charges is to use a 0% APR credit card. These cards typically offer interest-free financing on purchases or balance transfers for up to 21 months. As long as you pay the balance before the interest-free promotion period expires, you will not be responsible for paying the interest. Once the promotional period expires, any outstanding balance will begin to earn interest.
Benefits of a CD loan
- Lower interest rates compared to other products
- Fewer qualifying requirements which means they are good for borrowers with low credit scores
- You can avoid an early withdrawal penalty
- Your CD money continues to earn interest even when you pay off the loan
Disadvantages of a CD loan
- You are limited to borrowing the amount you have on your CD
- If you are in default on your CD loan, the bank can take the money from your CD
- Some lenders charge a origination fee, which increases the cost of borrowing and reduces the loan amount
Frequently Asked Questions (FAQ)
Does a CD loan create credit?
Paying off your CD loan as promised can help you increase your credit. Payment history is a key factor that makes up your credit score, accounting for 35%. This means that if you default on your loan it can negatively impact your credit score. Make sure you have a repayment plan in place before you take any money out.
Are CD Secured Loans a Good Idea?
If you need to cover an emergency expense, if your credit is damaged, or if you don’t want to be hit with early withdrawal fees, 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 may repossess the funds in your account.
How long will it take to get the funds after my CD loan is approved?
The length of time varies depending on the bank, but after your approval, some banks will issue your funds the next business day.