How to Use a CD to Pay Down a Loan
By Brian O'Connell
Certificates of deposit are the Swiss army knife of Wall Street � they have lots of handy uses. One creative way to leverage your CD investment is to use it as collateral to pay down a loan.
But is it a good idea to use a CD to pay down debt � and if so, what�s the best scenario to do so?
Let�s take a look under the hood.
First some basics. The Holy Grail in any loan payment campaign is to erase the interest payments on the debt � that�s why you want to pay a debt off as fast as you can in the first place.
Take credit cards. The average interest rate on a national credit card is about 14%
Compare that to the 1.5% yield on the average two-year certificate of deposit, based on this week�s BankingMyWay National CD Rate Tracker.
So if you�re nearing the end of your two-year CD maturity, you can use the money from that account to pay off a credit card burdened with a much higher interest rate.
Let�s say, for example, that you have a $1,000 credit card debt, at that average interest rate of 14%. By using your CD to pay the debt off, you�d save $140 in interest over the course of a year (ex: $1,000 x 14.0% - $140).
Of course, you�d lose interest you could have earned by plowing the money back into that two-year CD at 1.5%. At a $1,000 investment, we�re not talking a lot of dough, however ($15).
In that scenario, using your CD money to pay down high-interest credit cards is almost a no-brainer.
But credit card loans are notoriously harsh because of their high rates. If you have student loan debt, or an auto loan, those interest rates aren�t as high. Thus they might not be good candidates for using a CD � or borrowing against a CD if you�re low on funds � to pay down that debt.
That�s especially true if you cash out a CD to pay off a student loan or car loan. Some banks charge hefty fees for getting out early � 90 days of interest on a three-month CD isn�t uncommon, nor are 30 months worth of interest on a five-year CD.
Your best bet? Do a �cost benefit� analysis of what you�ll pay to cash out of a CD to pay down debt. Chances are that paying off higher rate debts, like credit cards, is still a smart financial move. But for lower-rate debt, you�ll want to know exactly you�re up against if you cash out of a CD early.
BankingMyWay has two calculators that can help you out. The Certificate of Deposit Calculator can help you figure out your interest rate and your final balance. And the Credit Card Payoff Calculator helps you calculate the different scenarios in paying off your credit card bill.
For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.