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How a CD Loan Works


In volatile markets, certificates of deposit (CDs) stand as a beacon of stability and opportunity through their unique blend of security and growth potential. However, surprise expenses can come up, leaving you wishing you could withdraw your funds before the term expires. Fortunately, CD loans are available at some banks and credit unions, allowing you to leverage your CD as collateral for a personal loan. Here’s how it works and when it’s more beneficial than an early withdrawal. You may want to consult with a financial advisor to make sure that taking a loan won’t impact your retirement planning.

What Is a Certificate of Deposit (CD)?

A certificate of deposit (CD) is a savings vehicle you can purchase from banks and credit unions. It is a low-risk financial instrument that typically provides a higher interest rate than a regular savings account.

When you open a CD, you agree to deposit a specific amount of money with the bank for a fixed period of time, known as the “term.” Terms can range from a few months to several years. In return for locking in your money for a set period, the bank offers you a higher interest rate than what you would get from a regular savings account. Longer terms can earn you higher interest rates.

Unlike other assets, CDs are low-risk because they have free FDIC insurance, meaning you’ll receive your CD funds up to $250,000 regardless of whether the bank or credit union you do business with fails in the future. However, the drawback of a CD is that you agree not to withdraw the money until the term expires. If you need to withdraw the funds before the term expires, you’ll usually incur a penalty and may have to forfeit your interest earnings.

What Is a CD Loan?

A CD loan is a personal loan you take out using your CD as collateral. Securing your loan with a CD can provide better loan terms and rates. The tradeoff is you will lose your CD to your creditor if you default on the loan.

How a CD Loan Works?

To get a CD loan, you’ll pledge your existing certificate of deposit as security. This way, your lender can recoup funds if you don’t repay the loan. Therefore, your CD loan poses less risk for the lender. Because the loan is secured by the CD, it poses a very low risk for the lender. The loan interest rate will likely be higher than your CD rate, providing the lender with additional revenue.

You, the borrower, must keep the CD with the financial institution that issued the loan until you’ve repaid the loan. The CD continues to earn interest, but you won’t be able to withdraw it until after you pay the loan in full.

Pros and Cons of a CD Loan

You can use CD loans wisely after understanding the advantages and disadvantages. Here’s what to know, starting with five common benefits: 

  • Quick application process: Applying for a CD loan is typically swift and straightforward. Your preexisting relationship with the financial institution and the included collateral expedite the process. These factors can lead to an approval within hours of applying.
  • Uninterrupted growth: While the CD is collateral for the loan, it still earns interest. As a result, even though you’ve used it as security for the loan, it continues to grow in value, providing you with a source of passive income.
  • Favorable terms: CD loans often come with favorable terms, including lower interest rates than other types of loans. In addition, you can receive terms of up to 10 years.
  • Lower credit barrier: Traditional loans often require a strong credit score for approval. With a CD loan, the focus is primarily on the collateral (the CD) rather than your creditworthiness. This advantage allows borrowers with lower credit scores to qualify for a CD loan.
  • Credit-building tool: If you have a challenged credit history or haven’t been able to build much credit, a CD loan can be a stepping stone to a better credit score. Borrowers can boost their scores by making regular, on-time payments and paying the loan in full.

Here are four common drawbacks that you should consider:

  • Limited availability: Not all financial institutions provide CD loans. So, if your bank or credit union doesn’t provide this type of loan, you may need to open a CD elsewhere. 
  • Fees: While CD loans may have favorable interest rates, they usually incur specific fees. For example, you may be responsible for application fees, origination fees or prepayment fees. 
  • Liquidity issues: When you use a CD as collateral for a loan, you lock away the funds in the CD until the loan is repaid. You won’t have access to the money in the CD for other purposes until you settle your debt. This aspect reduces the liquidity of your CD. 
  • Risk of asset loss: If you struggle to make the required payments on the CD loan and default on the loan, the financial institution has the right to use the CD to cover the outstanding debt. This event would result in you losing your CD. In this case, an unsecured personal loan would be more advantageous because it doesn’t require collateral.

CD Loan vs. CD Early Withdrawal

A woman assessing her financial situation for a CD loan.

When considering your financial situation, you may wonder whether a CD loan is more cost-effective than withdrawing your CD before the term ends. Because a CD loan incurs interest and an early withdrawal incurs penalty fees, each scenario depends on how expensive each cost is. Remember, every bank and credit union has its own CD guidelines. You’ll need to calculate the expenses based on your unique situation.

For example, say you have $10,000 in a five-year CD with a 5.00% APY. You’re one year into the term. You want to borrow $10,000 and your bank offers a 4-year CD loan with an APR of 7.50%. There are no origination or application fees. Here’s a breakdown of the cost of both options.

If you get the CD loan, in the next four years, you’ll earn $2,155.06 in interest on your CD and pay $1,605.87 in interest charges on the CD loan. Therefore, you’ll earn $549.19 interest on your CD after paying your loan interest.

On the other hand, your bank charges 180 days of interest for withdrawing your funds before the term expiration, producing a different result for early withdrawal:

Because you’re one year into the term, you earn $500 in interest on your CD. However, you’ll pay 180 days of interest as an early withdrawal penalty, incurring a charge of $246.57. So, you’re left with a $253.42 profit. Therefore, a CD loan provides a better return, although you must wait for the CD to mature to reap the full benefit.

CD Loan Alternatives

Fortunately, other loans that don’t affect your CD are available. If you don’t have a CD or want to leave it untouched, here are four common alternatives to consider:

Savings Account/Emergency Fund:

A savings account or an emergency fund is a standard, easily accessible source of funding with no withdrawal penalties. This source is highly liquid and isn’t a form of debt. Plus, savings accounts usually have lower interest rates than CDs. As a result, you can leave the passive income from your CD undisturbed.

Unsecured Loan

An unsecured loan is a borrowing arrangement where you don’t provide collateral. Lenders assess your creditworthiness through your credit score, income and financial history. This way, you aren’t risking your assets to get a loan and can use your financial profile to prove your reliability as a borrower. However, unsecured loans typically have higher interest rates, which can offset the interest your CD earns.

Credit Card

A credit card is an accessible form of debt, providing you with a revolving line of credit. Credit cards have cashback perks and don’t require a loan application. Plus, you don’t have to pay off the balance in full. Instead, you can make minimum payments and incur interest charges on the remaining balance. However, doing so means the debt can spiral out of control, especially because credit cards have higher interest rates than other forms of debt. 

No-Penalty CD

A no-penalty CD is a type of certificate of deposit that allows you to withdraw your funds before the term expires without incurring a penalty. This account provides a balance between the benefits of a CD and the liquidity of a savings account. However, your bank can still impose withdrawal restrictions (such as a specific period of time before you can access the funds) and lower interest rates than standard CDs. 

Bottom Line

A couple assessing whether they should take out a CD loan.

A Certificate of Deposit (CD) loan utilizes the account as collateral for a personal loan, providing favorable terms and minimal credit requirements. While it uses the account to secure the loan, the CD remains intact and continues earning interest. However, this loan risks the loss of the CD and can incur fees and interest charges that outpace the CD’s APY. Making an informed decision hinges on understanding your financial situation, goals and the terms your financial institution offers.

CD Loan Tips

  • financial advisor can analyze your financial situation and recommend the loan types that fit your needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Interest charges on CD loans can be a concern. Fortunately, you can outpace the APR of a CD loan with a market-linked CD, which tracks with the stock market. You’ll have higher earning potential than a standard CD, which uses your bank’s interest rate.

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