What Is a CD Loan, and How Does it Work?

When you’re in a tough financial spot, dipping into your savings may feel like your only choice. But if your money is locked away in a certificate of deposit (CD) and the financial institution offers the option, you may be able to apply for a CD loan to get the funds you need.

A CD is a type of savings account that you can find at many banks and credit unions. When you get a CD, you deposit a specific amount of money and agree not to touch it for a defined period of time — typically three months to five years — in exchange for earning a fixed interest rate.¹ If you withdraw your money early, you’ll have to pay a penalty. A CD loan could be a less expensive way to access extra money if you need it.

Learn more about what a CD loan is, including how it works, the pros and cons — and how to figure out if it’s the right fit for you.

What is a CD loan?

A CD loan is a secured loan, a type of loan that is backed by collateral, or something valuable that you possess, like a car or house. In the case of a CD loan, the collateral is the CD itself. The amount of a CD loan is typically based on the value of the CD. For example, if you have $2,000 in your CD, you may be able to borrow up to that amount if you take out a CD loan.

How does a CD loan work?

When you take out a CD loan, you pledge your existing CD as collateral. The CD serves as security on the loan, and the lender can seize the CD if you fail to repay the loan.

If you’re approved, the bank or credit union will offer you a lump sum that you must repay before the CD term ends.² You may use the funds for almost anything, like emergency expenses or home improvement costs.

A CD-secured loan is an installment loan, meaning you pay it back monthly with interest (the cost of borrowing). Note that your CD loan’s interest rate may be higher than what you earn on the CD. Interest rates typically start at about 2% to 3% above your CD’s rate, but they can be higher depending on the lender and your credit history.³ So, if your CD pays 5% interest, your loan’s interest rate could be around 7% to 8%. The good news is that the interest you earn on the CD could help offset some of the interest you pay on the loan.

The bank holds onto your CD while the loan is active. You continue earning interest on the CD but can’t use it until the loan term ends. If you don’t pay back your loan, the bank may take your CD to recover its losses.

Your loan term will generally end before or around the CD maturity date — that is, the date your CD term ends.⁴ Once you pay off the loan and the CD matures, you can withdraw the full value of your CD without incurring early withdrawal penalties.

Pros and cons of a CD loan

A CD loan may be a good option if you need money and want to avoid the early withdrawal penalty, but it’s not for everyone. Before you move forward, compare the costs of the loan’s interest to what you’d pay in early withdrawal fees. If the penalty is cheaper, tapping your CD directly could be the better choice.

Weigh these pros and cons to help you decide whether a CD loan makes sense for your budget.

Pros

• Lower interest rates: Like most secured loans, CD loans typically have lower interest rates than unsecured loans, since you’ll use your CD as collateral and pose less risk to the lender. Interest rates also tend to be lower than they are for credit cards.
• Your CD continues to earn interest: Your CD will continue to grow while the bank holds it, so you’re not missing out on potential earnings.
• CD loans could help build credit: Paying off your CD loan on time could help you build a stronger credit history.

Cons

• CD loans may come with fees: Some lenders charge fees, like an origination fee — a one-time cost for processing an application or setting up the loan — in addition to any interest you’ll pay while paying back the loan.⁵
• Not all banks or credit unions offer CD loans: If your bank or credit union doesn’t provide CD loans, you may have a hard time finding one elsewhere. In many cases, your CD will need to be at the same bank that offers the CD loan.⁶
• Defaulting could hurt your credit: Lenders will report missed payments to at least one of the three major credit bureaus after about 30 days. Missing payments may damage your credit score.
• The bank may seize your CD: If you fail to repay the loan, the bank could take ownership of your CD to recover its losses.

Who might benefit from a CD loan?

Not everyone benefits from a CD loan, but it could make sense in certain situations, especially if any of the following situations apply to you:

You need money, but don’t want to incur penalties

If you have a CD that’s locked in for another year, but an unexpected expense pops up, borrowing against the CD may cost you a little less than cashing out your CD early. But be sure to weigh the interest cost against the early withdrawal penalty first.

You want to build your credit

If you’re new to credit or working to improve your credit score, a CD loan could be a lower-risk way to show lenders you can manage your finances responsibly. That’s because lenders typically report your payment activities to credit bureaus. But make sure you have the funds to repay the loan if building credit is your goal.

You want to minimize credit card debt

Credit cards are another convenient way to cover expenses, but many come at a cost. Many credit cards have an average annual percentage rate of about 25%, while the interest rate for CD loans is typically much lower.⁷ For example, some lenders set the minimum CD loan rate at 2% above the CD’s interest rate, so if the CD earns 1% in interest, a CD loan will have a 3% interest rate.⁸

How to apply for a CD loan

Here’s how to borrow against your CD.

• Contact your bank or credit union: You’ll typically need to get your CD loan from the same bank or credit union where your CD is held, so make sure your financial institution offers them.⁹ If they do, you may be able to apply for a CD loan directly on the website, in person or over the phone.
• Confirm you meet eligibility requirements: Eligibility requirements vary, so make sure your financial profile, such as income and credit history, meets the criteria before applying. Most CD loans require that you have an active CD account and enough value in the CD for the loan to cover the borrowed amount. You may also have to meet other eligibility standards regarding your income and creditworthiness.
• Submit an application: Once you’re ready, submit the application. You’ll likely need to provide basic personal information, such as your Social Security number and your financial details.
• Review the loan terms: If you’re approved, go over the loan amount, interest rate, repayment schedule and fees to make sure the terms work with your budget.
• Sign the agreement and receive your funds: After you sign the agreement, you’ll typically receive the funds in as few as one to two days.¹⁰ You can use the funds to pay for medical expenses, wedding costs, a car repair or other needs.

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Turn your savings into support

If you already have a CD, taking out a CD loan may be a lower-risk way to borrow without dipping into your savings. But it may not make financial sense for everyone. Before applying, make sure you’ve compared it with other options like a personal loan, a credit card with a low introductory or promotional annual percentage rate (APR), or a home equity line of credit. You can also talk to a financial advisor if you need help making your decision.

Sources:

1. https://www.investopedia.com/terms/c/certificateofdeposit.asp
   
2. https://www.investopedia.com/terms/c/certificateofdeposit.asp
   
3. https://www.experian.com/blogs/ask-experian/what-is-a-cd-loan/
   
4. https://www.nerdwallet.com/article/banking/cd-loan
   
5. https://www.investopedia.com/what-is-a-cd-secured-loan-5225109
   
6. https://www.investopedia.com/what-is-a-cd-secured-loan-5225109
   
7. https://www.forbes.com/advisor/credit-cards/average-credit-card-interest-rate/
   
8. https://www.nerdwallet.com/article/banking/cd-loan
   
9. https://www.investopedia.com/what-is-a-cd-secured-loan-5225109
   
10. https://www.nerdwallet.com/article/banking/cd-loan