Certificates of deposit can be a useful tool for saving for short- or long-term goals. But it’s also possible to use a CD to secure a loan.
A CD-secured loan, also referred to as a CD/savings secured loan or share-secured loan, is a type of personal loan that uses the value of a CD account as collateral. They can be found through banks, credit unions, and online lenders.
Here’s a closer look at how CD loans work and how they stack up against unsecured personal loans.
What Is a CD Loan?
With a CD-secured loan, the lender holding your CD uses the money in your CD as collateral. If you don’t repay the loan, the bank can use the CD to cover any losses.
Let’s also answer what is a certificate of deposit? When you open a CD account, you’re depositing a certain amount of money for an agreed-upon time period. During this maturity period, the bank or credit union pays you interest on the money you’ve allotted to the CD.
At the end of the term, you could withdraw your initial deposit and interest earned or roll it over to a new CD. If you withdraw the money early, you’ll pay a penalty. To avoid that, a CD loan could come in handy.
You may invest in CDs if you’re looking for a safe place to keep your money while earning interest. Similar to savings accounts and money market accounts, CDs come with FDIC protection, up to the applicable limits.
How Do CD-Secured Loans Work?
If you take out a CD loan, the lender will charge interest. So you’ll be earning interest on the CD but paying interest on the CD-secured loan (if your CD is paying under 1%, loan rates might start at 2% over that rate).
Some of the general characteristics of CD loans are:
• Low fixed interest rates
• Predictable monthly payments
• Continued interest earned on the CD funds
• Can use the loan for a variety of expenses
How much you can borrow with a CD-secured loan depends on the lender. You may be able to borrow a particular maximum dollar amount based on your CD value or up to 100% of the value.
Some lenders establish a set end for repaying the loan, and others give you the entirety of the CD term to repay what’s owed. In addition, some may offer an interest rate reduction when you enroll in automatic payments and no prepayment penalty if you repay the loan early.
Who Might CD Loans Be Right For?
In general, you might consider a CD loan if:
• You have cash saved in a CD that you’re comfortable using as collateral for a loan
• You have a financial emergency and you want to be able to access the money in your CD without paying an early withdrawal penalty
• You’re unsure if you’d be able to qualify for another loan or line of credit based on your credit history or income
• Your bank or credit union’s CD loan terms are more attractive than the options
With that in mind, here are the main pros and cons to weigh with a CD/savings secured loan.
CD Loan Pros
A CD-secured loan may offer these benefits:
• Interest rate may be lower than other personal loans
• Predictable payments, thanks to a fixed rate
• The ability to build credit
• Earning of some interest as your CD matures
• Avoidance of early withdrawal penalty
• Potentially faster and easier approval than for other types of loans
CD Loan Cons
Here’s why you might think twice about a CD loan:
• You risk forfeiting all the money in your CD if you default on the loan
• Your CD funds may be frozen during the loan term so you won’t be able to make emergency withdrawals if needed
• CD loans aren’t as common as other types of personal loans, so your bank or credit union may not offer them
• Your lender may charge fees
• Borrowing limits are determined by your CD’s value
CD Loan vs. Personal Loan
While CD-secured loans can be convenient, there are reasons why you may want to consider an unsecured personal loan instead.
You don’t have to put your savings or other assets on the line to borrow money, and you don’t risk losing them if you default on a personal loan for some reason.
Next, you may be able to borrow more with a personal loan than you could with a CD-secured loan.
You may be able to find and get approved for an unsecured personal loan with an interest rate that is competitive with a CD loan’s. Lenders may consider:
• How much you want to borrow
• What the money will be used for
• Your credit scores
• Income
Recommended: What Is Considered a Bad Credit Score?
The Takeaway
CD-secured loan or unsecured personal loan? Each has its benefits and drawbacks. Borrowing from a certificate of deposit puts it at risk if, for any reason, you can’t repay the loan.
SoFi offers unsecured personal loans ranging from $5,000 to $100,000 with a fixed rate and no fees required.
Photo credit: iStock/PeopleImages
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