What is a CD Secured Loan?

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A CD loan is a type of personal loan you obtain by putting up a certificate of deposit as collateral. Because this means the bank can take the money in your CD if you default, the interest rate on CD secured loans tends to be lower. A CD loan is a good option if you already have a CD and need quick cash for a short-term emergency, or if you are looking for a way to build credit history.

How Does a CD Loan Work?

Certificates of deposit (CDs) are most often used as a savings tool, but some financial institutions allow CD holders to borrow against the money in an existing CD. CD loans come with fixed payments of principal and interest over the life of the loan. The payment is based on loan amount, duration and interest rate.

Low interest ratesMust already have a CD or be willing to open one
Easier to qualify for than unsecured loansYou often must pay an early withdrawal fee
Funds accessible quicklyYou must pay interest on the CD loan, which is greater than the interest you earn
Budget-friendly installment paymentsNot offered by all institutions
You continue to earn interest on the funds in the CD

Loan amounts vary by bank, but can range from $1,000 to as much as $250,000. Some banks also won’t allow you to borrow the full CD amount. The interest rate on CD loans is much lower than those charged by credit cards, unsecured loans or riskier loans —like payday or title loans. That’s because it’s a less risky loan for a bank to provide, since the loan is secured by money that you have already deposited. CD-secured loans can also come with an origination fee, a penalty fee for paying off the loan early, and a fee for early withdrawal.

Qualifying for a CD loan isn’t as difficult as for other loans, because the bank already holds your money in the CD as collateral. So, it’s easier and usually faster to get approval. Many banks may approve your CD-secured loan even if your debt-to-income ratio is high or your credit score is low, and you wouldn’t otherwise qualify for other unsecured loans. In other cases, the bank may forgo a credit check altogether.

Does a CD Loan Build Credit?

CD-secured loans can also be used to build or rebuild your credit history. Because qualifying for a CD loan is easier than other loans, it’s a good option for people who have little to no credit history, or whose credit history needs major improvement. Ask your financial institution if it sends CD loan payment history to at least one of the three major credit reporting bureaus: Experian, Equifax and TransUnion. Then, make on-time payments until the loan is paid off to build a positive credit history. Remember: If you miss payments, that also will be reported to the credit bureaus and hurt your credit history.

The advantage of a CD-secured loan as a way to build credit is that you already have the deposit at your financial institution to be used as collateral. Although secured credit cards are another good way to build credit history, you have to come up with a deposit first before opening an account. That may make it harder for someone who wants to start building credit immediately, but has to wait to save up enough for a deposit. A CD-secured loan may be a better choice in that case.

Should I Get a CD-Secured Loan?

CD loans are a good smaller-dollar loan option if you already have a certificate of deposit with your financial institution. Unfortunately, many major banks such as Bank of America and Chase do not offer these types of loans, even though they provide CDs. Wells Fargo and SunTrust Bank are among the bigger retail banks that offer CD-secured loans, and community banks and credit unions often provide them as well.

Before taking out a CD loan, explore whether simply cashing out your CD is the cheaper option. In some cases, the cost of getting a CD-secured loan—origination fee plus interest on the loan—is greater than the CD’s early withdrawal penalty, which is typically equal to three to six months of earned interest. Several banks, including Ally Bank and CIT Bank, also provide risk-free CDs that allow you to withdraw the funds without penalty. Their CD rates are competitive, too, up to 1.5%. To illustrate, consider a two-year, $5,000 CD that pays 1.25% in interest, compounded daily. You need $5,000 to replace the roof, but it’s only one year into the CD. Here are your two options:

Option 1: Withdraw early.

  • Determine how much interest the CD has earned over the past 12 months. The formula for your final balance is: original balance x (1+(interest rate/365))^(times compounded). In this case, this looks like $5,000 x (1+(0.04/365))^365 = $5,063. This shows that you've earned a total of $63 in interest.
  • Calculate six months of interest, which is the penalty for withdrawing early. Not all banks may calculate their penalties the same, so we estimate that six months will simply be half of the total for the year, or $63/2 = $31.50.
  • Ultimately, you lose $31.50 in penalties, but keep $31.50 in interest. The cost of withdrawing early is $0.

Option 2:

  • Get a 12-month CD loan with a 4% interest rate and origination fee of $50.
  • Calculate the total interest you will pay over the life of the loan using a loan amortization calculator. In this case, it’s $108.99.
  • Add the origination fee (if one exists) to the total interest you will pay on the loan. Here, it’s $50 + $108.99 = $158.99.
  • Using a CD calculator, figure out the total interest you will earn over the life of the two-year CD. That figure is $127.
  • Subtract the origination fee/interest paid from the interest earned ($127 - $158.99 = -$31.99) to find out if you earned more than you paid. In this case, you didn’t earn more. The cost of a CD loan is $31.99.

The bottom line: Given these two options, it costs nothing to withdraw the $5,000 early, but you will ultimately pay $31.99 if you take out the loan. In this example, it costs less to withdraw from the CD, and, ideally, you would put the money you save each month from not paying off the loan into a better savings vehicle, such as your 401(k) plan. But every scenario is different and it pays to do the quick calculation and comparison.

If you’re looking into a CD loan as a way to build credit, you may want to consider other types of secured loans and lines of credit that help your credit. Some banks offer loans and credit lines backed by money in your savings account. This may be a better option if you need the looser requirements of a secured loan, but don’t have money in a CD. Most banks, credit card companies and credit unions offer secured credit cards that are also popular for building credit. The security deposit required for these cards can be as low as $200, much lower than minimum amounts needed to fund many CDs.

Janna is a former Senior Writer at ValuePenguin covering banking, credit cards and credit scores. She has spent more than a decade writing and reporting on personal finance, real estate and business, and has received three journalism awards for her work.