A CD-secured loan is a loan that uses a certificate of deposit (CD) from a bank or credit union as collateral, which can allow you to borrow money. A CD-secured loan can offer competitive interest rates, but there are downside to consider as well, such as the fact that you could lose your CD if you can't meet the terms of the loan.
Key Takeaways
- CD-secured loans are loans that allow you to borrow money using a certificate of deposit (CD) as collateral.
- You can generally get low interest rates with CD-secured loans because they are fairly low risk for lenders.
- CD-secured loans may be useful for people with low credit scores or limited credit histories who might not qualify for other types of loans.
- One drawback of using a CD-secured loan is that you could lose your CD if you cannot meet the terms of the loan.
How CD-Secured Loans Work
When you buy a CD, you agree to leave your money with issuing bank or credit union for a set length of time, ranging from a few months to a number of years. In exchange, the issuer promises to pay a guaranteed fixed rate of interest on your money that's typically higher than you could get on a regular savings account.
Because CDs offer a guaranteed return and, because are usually insured by either the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA), they are considered safe investments. The FDIC or NCUA will insure CDs for up to $250,000.
However, a CD has disadvantages if you need to get your money out before its term comes to an end, such as if you need to pay for emergency expenses. You can usually cash-out or withdraw money from a CD prematurely, but you will most likely face an early withdrawal penalty.
An alternative is to take out a personal loan from a bank or credit union, using the money in your CD as collateral. A loan of this type is called a CD-secured loan or a CD loan.
Using a CD to secure a loans lowers the risk for financial institutions, so they can charge relatively low interest rates. However, if you can't pay back the loan, the bank may take ownership of your CD.
If you default on a CD-secured loan, the bank or credit union may not only take your CD to cover your loan payments, but might charge you an early-withdrawal penalty.
Pros and Cons of CD-Secured Loans
CD-secured loans can be a good way to borrow money if you have sudden emergency expenses. They often provide better interest rates than credit cards and you can often borrow up to 100% of the value of the CD for your loan and get approved quickly.
Here are more details about the advantages and disadvantages of using CDs to secure a loan.
Pros of CD-secured loans
- Low interest rates: Because CD-secured loans present very little risk to lenders, the rates of interest they charge are generally quite low.
- Long repayment terms: Banks and credit unions may offer longer repayment periods on CD-secured loans, allowing you to pay the loan back over the term of the CD.
- Fast approval: Banks often can approve borrowers for CD-loans fairly quickly, typically within one business day. This makes CD-secured loans a good source of funds for emergency expenses.
- Fewer qualification requirements: Borrowers with poor credit or little credit history may be able to qualify for a CD-secured loan. Lenders consider these loans lower risk because of their collateral. Paying the loan back on time can help you establish a good credit history and boost their credit score.
- Continued interest on CD: While you are using your CD as collateral, it will continue to earn interest for you.
Cons of CD-secured loans
- You need a CD: Obviously, a CD-secured loan isn't an option unless you already have a CD or are willing to open one. That means tying up your money in an investment with a relatively low rate of return.
- Low availability: Not all banks and credit unions offer CD-secured loans, so you might have to shop around to find one. When you take out a CD-secured loan, you may have to use the same bank that issued the CD for the loan.
- No access to CD funds: Because your CD is used as collateral for your loan, you won't have access to that money until the loan is repaid.
Alternatives to a CD-Secured Loan
A CD-secured loan is not your only option for borrowing money. These alternative sources of financing or payment methods are worth considering if you don't have a CD and you don't want to buy one:
- A share-secured or passbook loan: These loans use your savings account as collateral and, like CD-secured loans, tend to offer competitive interest rates. That way, you don't have to take out a CD to borrow against your savings.
- A short-term personal loan: If you can get approved for a short-term personal loan from a bank or credit union, you might find that you can access more money than with a CD-secured loan, which is limited by the amount of the CD.
- A secured credit card: A secured credit card is designed for people with poor credit or no credit history yet. You make a deposit, which then serves as your credit limit. As you charge purchases and make on-time payments, your credit score should improve, making you eligible for a regular, unsecured credit card and other types of loans. However, you will need to use cash for a deposit with a credit card issuer.
Who Is a CD-Secured Loan Best For?
CD-secured loans are most appropriate for people who have a CD and need to borrow money. They may be used by people who don't have other savings to tap or other investments to use as collateral. These loans can also be beneficial to people who wouldn't qualify for an unsecured personal loan.
Does a CD-Secured Loan Build Credit?
A CD-secured loan can help you build credit. Your payments on the loan will be reported to the credit agencies, so taking out a CD-secured loan and making all the payments on time can be a way to improve your credit score.
Is a CD-Secured Loan the Same as a Credit-Builder Loan?
Both a CD-secured loan and a credit-builder loan can help you establish good credit, but they work differently. With a CD-secured loan, you deposit money in a CD and use it as collateral to borrow against. With a typical credit-builder loan, a bank or credit union will lend you the money to put in your CD (or other savings account). As you make loan payments, the lender will report them to the credit bureaus. Once you've paid off the loan, the money is yours to keep.
The Bottom Line
CD-secured loans are a way of borrowing money against a certificate of deposit (CD) and can be an attractive alternative to cashing in the CD and paying an early-withdrawal penalty. CD loans generally have low interest rates because they are low-risk for lenders. They are also more available to people with poor credit or no credit history and can help them build a good credit score. However, the main risk to consider is that if you are unable to pay the loan back, you could lose your CD.
