Updated on 12.08.16

Can a CD Loan Help You Build Credit or Tap Emergency Cash?

If you've got money stashed in a certificate of deposit, you may be able to borrow against it without paying an early withdrawal penalty.

Here’s an approach to establishing, building, or repairing credit that few people are likely aware of: a CD loan.

More specifically, the process usually involves opening a secured credit card with a bank or credit union, which is backed by your certificate of deposit (CD). But that’s just one of the potential uses for what’s often referred to as a CD loan.

Such loans are also an option to consider when you need to tap some quick cash, and other sources of funding, such as a traditional loan or credit card, are simply not available.

The downside, however, is that fewer and fewer banks offer CD loans these days because the financial institution typically does not make much money on them. Not to mention that, in the age of low interest rates and high-yield online savings accounts, very few people even have CDs anymore, according to financial experts. What’s more, such loans are capped by the amount of cash in the CD.

“There’s a lot of limitations to them,” says Scott Vance, of North Carolina-based Trisuli Financial Advising. “But this is one of the possible tools you could consider if you need funding for something.”

Here are the key things to know about CD loans.

What Is a CD Loan?

First, for those who may be unclear, a CD is a time deposit account that involves tying up a sum of money for a fixed term, during which the money earns interest. Typically, the longer you agree not to touch the money, the higher the interest rate you’ll earn.

CD terms can be a month, three months, six months, or as long as three to five years. And here’s the key point – there’s a penalty for removing the money before that term has expired.

A CD loan however, allows you to borrow against the money you’ve deposited, without penalty.

Why Use a CD Loan?

There are various reasons to consider this approach to obtaining quick cash. Vance says he has seen clients opt for a CD loan when a sudden, unexpected need for money arises.

“When a client has a large amount of cash tied up in a CD, rather then totally cash out the CD and pay penalties, they can take a loan against that CD,” he explains.

This approach avoids the early withdrawal fees associated with a CD, yet still provides you with the emergency cash needed.

However, it’s important to note that the bank will charge interest on the CD loan. So it’s a good idea to be clear regarding how much interest you’ll be paying and whether this approach really makes the most financial sense.

“I had one client who had a lot of money tied up in three- to five-year CDs. And the roof on their house got damaged and needed to be repaired. They needed more cash to pay for the repairs then they had on hand,” explains Vance. “The interest rate for the CD loan in that case was less then a signature loan, or even a credit card.”

Using a CD Loan to Build Credit

Yet another use for CDs is building or repairing your credit. In this scenario, the money in the CD is used as collateral for a secured credit card or line of credit from a bank or credit union.

Ronit Rogoszinski, a New York-based certified financial planner and founder of Women & Wealth Solutions, used a CD loan to help her college-bound son open his first credit card and establish credit. She describes it as a simple process that made sense for a teen who did not yet have any credit history.

“When he went off to college, we wanted him to have a credit card,” explains Rogoszinski. “He applied for a major credit card and was declined.”

Rogoszinski took matters into her own hands by opening a $500 CD at a small, regional bank that offered secured credit cards. The bank put the money into an 18-month CD, which was used as collateral for the secured credit card provided to her son.

This approach served several purposes, says Rogoszinski. It allowed her son to establish a credit record, while also teaching him that there would be a penalty if the credit card was used inappropriately – in the form of his parents losing their $500.

“If you either have no credit or you have a child going off to college, and you don’t want them getting a regular credit card, this is a good option,” says Rogoszinski.

Like other financial advisors, Rogoszinski notes that few banks offer CD loans or lines of credit anymore. The most likely places to find them, she says, is regional banks and credit unions.

But the bottom line is that you still must come up with the money to put into the bank as collateral, if you don’t already have a CD established. And before taking this approach, make sure a CD loan is your best option.

“Good luck finding a bank still does them,” says Rogoszinski. “And if you do find one, make sure to read the terms of the loan very, very carefully… A CD might earn 1% on a good day. If you’re going to borrow against it, find out what the fees are. And if it ends up being a loan that charges 10%, don’t do it. It’s not worth it.”

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