CD Loan: What Is It and How Does It Work?

Article Summary:

CD loans are loans that use your certificate of deposit (CD) as collateral. If you default on your CD loan, the lender can seize the money in your CD. These loans are a great option for individuals who don’t have a great credit history and are hoping to build credit.

Applying for a loan can be discouraging if you have poor credit or no credit history. Many major banks and credit unions require that you have a minimum credit score to receive certain loans. But did you know there are loans available to people who have a poor credit history?

One of these loans is a CD loan. You do not need a good credit score or a good debt-to-income ratio to open a CD loan; instead, all you need is a certificate of deposit. But what is a certificate of deposit? And how exactly does a CD loan work? Let’s take a look at the pros and cons of CD loans so you can have a good idea of whether or not it’s the right option for you.

What is a certificate of deposit?

A certificate of deposit (CD) is a savings account that holds a set amount of money for a certain period of time. During this time, the money remains untouched and the bank or credit union pays interest on it. The date when you can withdraw money from your certificate of deposit is called the maturity date.

You typically earn more interest with a certificate of deposit than you would with a traditional savings account. The downside is that, unlike a normal savings account, you cannot access the money in a CD for a set amount of time. If you do, you could face a financial penalty. Some CDs also require that you deposit a minimum amount of money upon opening your account. Regardless, certificates of deposit are a safe and useful option for many individuals, including those with poor or no credit who need a secured loan.

What is a CD loan and how does it work?

A CD loan is a type of secured personal loan that uses your certificate of deposit as collateral. If you default on a CD-secured loan, the lender can take the money in your CD. The loan term is based on the maturity date of your CD — for example, if the maturity date of your CD is in six months, then your loan would be for six months as well.

CD-secured loans have fixed interest rates and tend to be lower than other personal loans. You’ll repay a CD loan in fixed monthly payments, which are based on the loan amount, the length of the loan, and the total interest rate.

CD loans tend to be considered less risky for banks than unsecured personal loans or credit cards, as the loan is backed by money you have already deposited.

Qualifications for a CD loan

CD-secured loans are fairly easy to obtain, and one reason for this is the easy qualification requirements. In many cases, you can qualify for a CD loan when you wouldn’t be eligible for other personal loans, particularly unsecured personal loans. The only real requirement for a CD loan is to have a certificate of deposit already set up. As long as you have one, you can receive a CD loan even if you have a low credit score, a high debt-to-income ratio, and a shaky credit history.

Pros and cons of a CD loan

Before you decide whether or not a CD-secured loan is the right choice for you, it’s a good idea to weigh the pros and cons of getting one. Let’s take a look at a few of the main advantages and disadvantages of a CD loan:

WEIGH THE RISKS AND BENEFITS

Here is a list of the benefits and drawbacks to consider.

Pros
  • Your interest grows
  • Easy to qualify for
  • Lower interest rates
  • Easy to access loan funds
  • Continue to build your credit history
  • Predictable payments
Cons
  • Must have a CD account
  • Not offered by all banks
  • Money in your CD is at risk
  • Likely can’t access CD funds
  • Borrowing limit
  • Fees
  • You are essentially paying interest for borrowing your own money

Pros of a CD-secured loan

Here are some of the advantages of a CD-secured loan:

Your interest grows

As you make your loan payments, you’ll continue to earn interest in your CD account.

Easy to qualify for

Because the money is already in the bank and there’s no required debt-to-income ratio or credit score, it’s pretty easy to qualify for a CD loan. So if you have a poor credit history, a CD loan could be a good option for you.

Lower interest rates

Interest rates for CD loans are much lower than rates on credit cards, payday loans, and unsecured loans. However, the rates would be even lower if you just used the cash in the CD.

Easy to access loan funds

After getting approved, you’ll generally get access to your loan fairly quickly.

Continue to build your credit history

A CD loan continues to build (or rebuild) your credit. So if you have a poor or nonexistent credit history, a CD-secured loan can help you improve it while giving you access to the funds you need. Just be sure to make your loan payments on time!

Predictable payments

Thanks to the low fixed interest rates of CD loans, you’ll know exactly how much your monthly payments will be each month. This will make budgeting much easier in the long run.

Cons of a CD-secured loan

Here are some of the disadvantages of a CD-secured loan:

Must have a CD account

You cannot get a CD loan without first opening a certificate of deposit. If you do not have one yet and you are not willing to open one, you won’t be approved for a CD loan.

Not offered by all banks

Not all banks offer CD-secured loans, so if you want one, your bank of choice may not be an option.

Money in your CD is at risk

Whenever you take out a secured loan, you risk the collateral you put down. In the case of a CD loan, you risk losing the money you have stored in your CD account if you default on the loan.

Likely can’t access CD funds

In case of an emergency, you may need to withdraw your CD funds early. If you don’t have a CD loan, you can simply access your CD funds and pay an early withdrawal fee. However, if you use your CD account as collateral for a CD-secured loan, some lenders may freeze the account, making it impossible to borrow money from it. This means if you have an emergency, you won’t be able to use your CD account to cover that expense.

Borrowing limit

The amount you borrow is limited to the amount of money in your certificate of deposit. So if you don’t have much money in your CD account, you won’t get a big loan.

Fees

Some lenders charge fees when you apply for a CD loan. This could lower the amount of the loan and increase the cost of borrowing money.

Who should get a CD loan?

Here are some questions to ask yourself to decide if a CD loan is right for you:

  • Do I have a certificate of deposit, and if not, am I willing to open one?
  • Am I willing to use the money I have saved in my CD as collateral for a loan?
  • Does my credit history prevent me from qualifying for another personal loan?
  • Am I satisfied with the length and terms of a CD loan?
  • Does a bank or credit union near me offer CD-secured loans?

If you answered yes to these questions, then a CD loan could be a great option for you. CD loans are best for individuals who have a certificate of deposit set up and are willing to use that money as collateral for a loan. A CD loan is also a reliable option if you have a poor credit history and need a good opportunity to build credit.

Bear in mind that not all banks offer these loans, and the length of your loan is determined by your CD maturity date. If you need a long-term loan but only have six months left until your CD matures, you should probably consider other options.

How do I get a CD loan?

Applying for a CD loan is fairly easy. Here’s a brief rundown of the steps you need to follow in order to get a CD loan:

How to apply for a CD-secured loan

  1. Open a CD account if you don’t already have one. A certificate of deposit is necessary to apply for a CD loan, so be sure you have one set up before you begin the application process.
  2. Apply for a CD loan. You can apply online or in person at a bank or credit union. Lenders will usually ask you to provide employment and personal contact information.
  3. Read the terms and conditions of the loan. Before you agree to anything, make sure you understand the loan term, the amount you’ll borrow, and the fees you’ll have to pay.
  4. Wait for a loan approval. The good news about CD loans is that they’re low risk, so they are usually approved fairly quickly.
  5. Sign the loan agreement. Once your loan is approved, your lender will send over the documents you need to sign. Review them once again, then sign them. Once the agreement is complete, you can start receiving your funds.

Alternatives to a CD loan

If for whatever reason you’re not interested in opening a certificate of deposit, there are other loans you can look into instead. Alternative solutions to CD-secured loans include secured credit cards, unsecured personal loans, and secured personal loans.

Secured credit card

This is another great option for individuals with poor or no credit. Secured credit cards are funded by an initial cash deposit, which is held as collateral. Using a secured credit card is a great way to build your credit.

Unsecured personal loan

Unsecured loans are not backed by collateral, but if you default on this type of loan, you’ll see a major drop in your credit score. You could also be sued by your lender if you do not pay off the loan. While these loans are riskier and can come with high interest rates, this could be a good long-term option, especially if you have a decent credit score.

Secured personal loan

Secured loans are loans backed by collateral. If you don’t have a certificate of deposit, you can still qualify for a secured loan if you have another asset to use as collateral instead. Cars, homes, jewelry, or your savings account are some of the assets you can use as collateral for a secured loan.

Pro Tip

Personal loans can be used to finance a number of expenses, including medical emergencies, vacations, home improvement projects, and education. They also offer competitive interest rates and are easy to apply for.

FAQ

Do CD loans help your credit?

Yes, making on-time payments on a CD loan can help build your credit.

What does CD stand for in banking?

CD stands for “certificate of deposit.” This is an account that holds a set amount of money for a certain period of time, during which the money cannot be withdrawn (without incurring the CD’s early withdrawal penalty).

How much can you borrow against a CD?

The amount you borrow against your CD is determined by how much money is in your CD account. For example, if you have $10,000 in your CD, your loan will be $10,000.

Can you withdraw money from a CD at any time?

While you can technically withdraw money from a CD at any time, you will incur an early withdrawal penalty fee for taking money from the account before the maturity date.

Does closing a CD hurt your credit?

Closing a CD account does not impact your credit. However, if you close the account before the maturity date, you will have to pay a penalty.

Key Takeaways

  • A CD loan is a loan that is backed by your certificate of deposit.
  • If you default on your CD loan, the lender can seize the money in your certificate of deposit.
  • The amount of your loan is determined by the amount of money in your CD account.
  • CD loans are a great option for borrowers with no credit history or a poor credit score.

If you’re interested in opening a certificate of deposit, be sure to compare rates before committing to one. See SuperMoney’s picks for the best CD accounts, and use our comparison tool to find a CD account that’s right for you!

View Article Sources
  1. Certificates of Deposit (CDs) – Investor.gov
  2. The Pros and Cons to CD Loans – Nasdaq
  3. What Is A CD Loan? – Forbes