What Is a CD Loan and How Does It Work?
Access funds without liquidating your CD. Learn how a Certificate of Deposit (CD) loan functions as a secured borrowing option.
A CD loan is a secured personal loan that uses a Certificate of Deposit (CD) as collateral. It allows individuals to access funds without liquidating their CD, ensuring the investment remains intact and continues to earn interest.
Understanding CD Loans
A CD loan leverages the deposited funds within a Certificate of Deposit as security. This reduces risk for the lender compared to unsecured loans, often leading to more favorable interest rates for the borrower.
The loan amount typically represents a significant percentage of the CD’s value, commonly ranging from 80% to 95% of the principal balance. The interest rate charged on a CD loan is generally structured to be slightly higher than the interest rate the CD itself is earning.
Repayment involves fixed monthly installments covering principal and interest over a specified term. The loan term often aligns with the CD’s remaining maturity period. During the loan’s duration, the CD remains with the lending institution, continues to accrue interest, and cannot be cashed out by the borrower.
Should a borrower default on the CD loan, the lending institution has the right to seize the CD and use its funds to cover the outstanding loan balance. This can negatively impact the borrower’s credit score.
Eligibility for a CD Loan
To qualify for a CD loan, certain criteria must be met by both the borrower and the Certificate of Deposit. The borrower must be the CD owner and a customer of the financial institution offering the loan. While a credit check may still be part of the process, it is often less stringent than for unsecured loans due to the presence of collateral.
The Certificate of Deposit used as collateral must meet specific requirements. It must be held at the same institution providing the loan. The CD cannot already be pledged as collateral for another loan, ensuring it is a clear asset for the new lending agreement.
The CD must be a non-retirement account CD; Individual Retirement Account (IRA) CDs are not eligible. The CD must also possess sufficient value to secure the desired loan amount and may require a minimum remaining term. It needs to be in good standing, free from any holds or other encumbrances.
The CD Loan Application Process
Initiating the application for a CD loan involves contacting the bank or credit union where the Certificate of Deposit is held. This can be done by visiting a branch, contacting customer service, or inquiring through the institution’s online portal.
During the application, borrowers provide identification, such as a government-issued ID, and details pertaining to the specific CD being used as collateral. Information regarding the desired loan amount and repayment term will also be requested.
The financial institution reviews the application and verifies the CD’s eligibility. Due to the secured nature of the loan, approval is often a relatively quick process.
Upon approval, the final step involves signing a loan agreement that outlines all terms, including the interest rate, repayment schedule, and consequences of default. Once executed, the loan funds are typically disbursed to the borrower, often directly into an account held at the same institution.