Personal Finance

The Pros and Cons to CD Loans

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Your options to borrow include a product that bridges the worlds of lending and saving. A CD loan is a type of personal loan you obtain by putting up a certificate of deposit as collateral. 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. 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.

Here are the pluses and minuses to a CD loan, so you can decide if one is a viable borrowing choice for you.

Pros

Low interest rates. 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.

Easy qualification. Getting one of these loans is less work and grief than obtaining an unsecured loan. Qualifying isn’t as difficult as for other loans because the bank already holds your money in the CD as collateral. 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.

Funds are accessible quickly. The fact that the bank itself is both holding the collateral and issuing the loan makes for relatively rapid disbursement of the funds you’re borrowing.

Budget-friendly installment payments. These can be fairly modest, adding to the appeal of this lending option.

You Can Build a Credit History. 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.

Cons

You must already have a CD or be willing to open one. 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. However, if that isn’t the case for you, this option for credit is not an option.

You often must pay an early withdrawal fee. 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.

Because of these charges, before taking out a CD loan, first 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%.

Not all institutions offer CD loans. 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.

This content originally appeared on ValuePenguin

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.