Understanding CD Loans: A Comprehensive Guide

At O1ne Mortgage, we strive to provide you with the best financial solutions tailored to your needs. If you’re considering a certificate of deposit (CD) loan, this guide will help you understand what it is, its pros and cons, and how to apply for one. For any mortgage service needs, feel free to call us at 213-732-3074.

What Is a CD Loan?

A CD loan is a type of secured loan that uses the funds in your CD as collateral. This can be particularly useful if you have difficulty qualifying for unsecured loans or if you prefer not to close your CD and incur an early withdrawal penalty. Essentially, a CD loan allows you to borrow against your own savings while keeping your CD intact.

CD loans are a form of secured personal loans, which means you receive a lump sum upfront and repay it in monthly installments. The terms of these loans can vary depending on your bank or credit union, but generally, here’s how they 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. Typically, 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: The loan’s term may be the same as the CD’s remaining term, and you’ll need to pay it 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.

For example, if you need to borrow $3,000 for an emergency expense and you have a $10,000 CD with a 5% APY, you might not want to close the entire CD and pay an early withdrawal penalty. 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

Before deciding on a CD loan, it’s essential to weigh the pros and cons to determine if it makes sense for your financial situation.

Pros

• Easy qualification: Although your credit may be a factor, your CD’s balance, interest rate, and maturity date will largely determine your loan’s terms.
• Fast funding: Your existing lender can quickly review and approve your application since they have easy access to your information and can keep your CD locked while your loan is outstanding. You may even 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. This rate may be lower than what you would receive with an unsecured loan, especially 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, helping you qualify for more loans and better terms in the future.

Cons

• Upfront fees: Some lenders charge application or origination fees, which increase your overall costs and may be subtracted from your loan amount.
• Higher cost 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 borrowing a percentage of the CD’s balance, such as 80% to 95%. Even if you can borrow the full amount, it 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 it 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, 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

If you think a CD loan might work out well for you, follow these four steps:

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. 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’s comparison tool can also help you find and compare personal loan offers based on your unique credit profile.

At O1ne Mortgage, we are committed to helping you find the best financial solutions. If you have any questions or need assistance with mortgage services, don’t hesitate to call us at 213-732-3074. We’re here to help you achieve your financial goals.