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A certificate of deposit (CD) loan is a type of secured loan that uses the funds in your CD as collateral. This type of loan can be helpful if you have trouble qualifying for unsecured loans or you don't want to close your CD and pay an early withdrawal penalty.
What Is a CD Loan?
CD loans are secured personal loans—a type of installment loan. You receive the loan amount as an upfront lump sum, and then pay off the loan with monthly payments. The specific terms can vary depending on your bank or credit union, but here's how CD loans generally work:
- Loan amount: You can borrow an amount between the minimum required loan amount and your CD's balance.
- Interest rate: CD loans often charge more interest than you earn on your CD. At the lowest, the interest rate may be your CD's rate plus 2% to 3%. But it could be higher depending on the lender or your creditworthiness.
- Repayment term: At most, the loan's term may be the same as the CD's remaining term, and you'll pay off by the time the CD matures.
- Repayment options: Most loans have fixed monthly payments and you can pay off the loan early without any penalties.
Similar to unsecured personal loans, you can use the money for almost anything. However, it may be easier to qualify for a CD loan, and you might receive a lower interest rate than you'd get with an unsecured loan. Although you'll pay more in interest than you're currently earning with your CD, a CD loan might still make financial sense.
Say you need to borrow $3,000 for an emergency expense. If you have a $10,000 CD with a 5% APY, you don't necessarily want to close the entire CD and pay an early withdrawal penalty, especially if you can't open a similar CD again. And perhaps you can only get preapproved for personal loan offers with APRs of 10% or higher.
A $3,000 CD loan with an 8% APR costs more than you earn with the 5% APY CD. But it's less expensive than an unsecured personal loan or high-rate credit card, and you can keep your CD open.
Pros and Cons of CD Loans
You may want to calculate the costs and savings—and consider the other pros and cons—to determine if a CD loan makes sense.
- Easy qualification: Although your credit may be a factor in the decision, your CD's balance, interest rate and maturity date will largely determine your loan's terms.
- Fast funding: It may be simple for your existing lender to review and approve your application because they have easy access to your information and can keep your CD locked while your loan is outstanding. You may even be able to access the loan within the same business day if it's deposited into an account at the same financial institution.
- Low interest rate: Lenders may offer CD-secured loans with an interest rate that's 2% to 3% higher than your CD's rate. The resulting interest rate may be lower than what you would receive with an unsecured loan, particularly if you don't have good credit.
- Build credit: Your on-time loan payments can be reported to the credit bureaus and improve your credit history. Having good credit can help you qualify for more loans and better terms in the future.
- There could be upfront fees: Some lenders charge application or origination fees which increase your overall costs and may be subtracted from your loan amount.
- Might cost more than cashing out your CD: Unless your CD has a large early withdrawal penalty, the overall cost of the CD loan may be higher than the cost or lost interest earnings from closing your CD early.
- Maximum loan amounts: You might be limited to only borrowing a percentage of the CD's balance, such as 80% to 95%. But even if you can borrow the full amount, that might not be enough for your current needs.
- Limited options: You likely won't open a CD to take out a loan against it—you'd often be better off using the cash directly. As a result, your loan options and terms will depend on where you already have CDs.
- Your CD is locked: Because your CD is collateral for the loan, you won't be able to withdraw money from the CD early.
Can I Use a CD Loan to Build Credit?
One reason to get a CD loan is that the CD loan and your monthly payments can help you build credit.
The new loan could be reported to the credit bureaus, which can increase your credit mix if you don't already have an open installment account. Your on-time payments can also help you build a positive payment history—the most important credit scoring factor. However, as with other types of loans, missing your payments and defaulting on the loan could hurt your credit scores.
Before applying, ask your bank or credit union which of the credit bureaus will be provided with loan and payment details. Many major financial institutions report to all three—Experian, TransUnion and Equifax. But some only report to one or two of the bureaus. As a result, your CD loan and on-time payments would only affect the credit scores based on your credit reports from those bureaus.
How to Apply for a CD Loan
Follow these four steps if you think a CD loan might work out well:
- Check if CD loans are available. If you have CDs at one or several financial institutions, check with each one to see if it offers CD loans and the qualifications and terms for its loans.
- Calculate your overall costs. Compare how much an early withdrawal will cost you in terms of penalties and lost interest earnings to the total cost of the CD loan. If you don't need to borrow the maximum amount, you may be able to save money by taking out a smaller CD loan.
- Follow the application instructions. Application processes vary, so check with your financial institution to find out how to get started. You may need to submit some basic information about yourself, the loan you want and agree to a hard credit inquiry.
- Review repayment instructions. Some lenders offer an interest rate discount if you sign up for automatic payments from an account at the same company, but you may need to choose this option when you first take out your loan.
CD-secured loans can offer you a lump sum loan loan. But if you want a more flexible funding option, some banks and credit unions also offer CD-secured personal lines of credit. These give you access to a maximum credit limit based on your CD's balance. You can take loans against the credit line when needed and you only pay interest on the amount you borrow.
Improve Your Credit to Expand Your Options
A higher credit score can help you qualify for more types of loans, including unsecured personal loans with low interest rates. You can check your FICO® Score☉ for free with an Experian account, and get free ongoing score tracking. If you're looking for a loan, Experian CreditMatch™ can also help you find and compare personal loan offers based on your unique credit profile.