Use Your CD to Stretch Your Dollars
Did you know that you can use your Certificate of Deposit (CD) as collateral to secure a loan? This is a little-known, and under-utilized option that can be used to make a purchase. It is also an excellent way for people with little or no credit history to establish credit or improve a low credit score.
It’s easy to forget about this option because once a CD is opened, that money may often be regarded as “tied-up”. That’s not necessarily true. In fact, there are incentives to making a loan using your CD rather than cashing in that money to pay for an expense. By borrowing the funds, you'll build a positive credit history, your CD will remain intact, and your savings stays secure as you pay off the loan.
Relatively Easy to Do
Approval for this type of loan is relatively quick, especially if the financial institution making the loan is also holding your CD. In most cases, a credit check may not be necessary. You may even find that most institutions are happy to offer this type of loan since the bank faces less risk than with other types of loans. Speak with a Loan Officer regarding:
- Loan-to-Value Ratio: Many times a CD loan allows you to borrow up to 100 percent of the money held in the CD.
- Interest Rate Charged: Is normally more favorable than a traditional loan because it is secured by the cash in your CD.
- Repayment Schedule: Regular payments are made and the term of the loan often relates to the term of the CD.
Paying Interest and Earning Interest
Your CD will continue to accrue interest during the loan period, so you’ll continue to gain more money in that CD even though you’ve “repurposed” the money on another expense. The rate you pay on loan interest will exceed the rate you earn, this margin between the two interest rates allows your bank to cover its administrative costs.
Example (for illustrative purposes only, your rates and terms will vary)
- 5 year CD, current balance $2,000 earning 1.50% APY
- 5 year loan, receive $2,000 cash at 3.50% APR, monthly payment $36.38
After 5 years
- CD total interest earned $154.39
- Loan total interest paid $183.01
- Interest Margin $28.62 + $40 in origination charges
Points to Remember
Though this is a relatively quick and easy loan to secure, there are some important points to remember.
- You will not be able to withdraw any funds from your CD during the loan term.
- You are pledging your CD as collateral for the debt. If you do not repay the loan, your bank can seize the CD and use the money to pay off the loan in default.
- A shorter term CD means larger monthly payments.
- Loan underwriting rules may require that you have an income source.