Finance Q&A - CDs as Collateral for a Loan

By Dan Thanh Dang

RISMEDIA, July 30, 2008-(MCT)-The credit crisis has made getting a loan a little more difficult these days. Frank Micriotti of Middle River wants to know why more people don’t take advantage of certificate of deposit loans.

“I’d like to educate the general public in our general area that this might be an option they might want to consider,” Micriotti said. “If you have a certificate of deposit, you can use it as a collateral loan. You have to be wise about it and you have to know what the positives and negatives are before you do it.

“But it’s definitely a good option for people who might need a loan,” Micriotti said.

The A: Why don’t people don’t take advantage of CD loans more often? Perhaps it’s because, like me, they don’t know that CD loans exist. I was surprised to learn that Bankrate.com calls CD loans “the other white meat” of loan products for some midsize and small community banks.

CD loans can help re-establish credit history and put borrowers on good footing with mortgage and car loan lenders, Bankrate says.

First, CDs are a relatively low-risk debt instrument that pays interest for a fixed length of time, ranging from three months to five years, at a specified rate.

Federally insured CDs pay higher rates of interest than simple savings accounts, but keep in mind that CD rates, terms and dollar amounts will vary from institution to institution.

In a CD loan, a depositor can take out a loan for up to 100% of the CD amount, secured by the CD itself. The loan, which usually offers low interest rates since the loan is secured by the cash in your account, is paid back during the term of the CD.

If you default on the loan, the bank can seize the money invested in the CD. If the loan isn’t repaid by the time the CD expires, Bankrate says, the depositor can renew the CD to extend and refinance the loan.

Since the CD continues to earn interest on a yearly or monthly basis, it offsets some of the interest you’re charged for taking out the loan. Getting the loan can also take minutes as opposed to days or weeks for unsecured loans.

For people who have bad credit or no credit history, CD loans offer a cheap and easy way to start establishing credit. Be sure to ask the bank if it reports CD loan payments to the credit bureaus before signing up.

The drawback to this loan is that you can only borrow against what you have in the CD. Typically, the minimum amount you can have in a CD is $500. If that’s all you have in the CD, that’s all you can borrow. Most banks will allow you to borrow 100% of the value in the CD, or close to it.

While your loan is limited to the value of your CD, it also forces you to spend only what you have.

Be aware that a bank probably will not give you a loan against a CD purchased at another bank. So check with the bank where your CD is located to see if you can secure a loan against it.