Personal Finance

A loan against your CD might be one option for quick cash. Here are the pros and cons

Key Points
  • While the stock market has taken a hit and selling now may lock in losses, CD owners may be able to access low-cost cash without actually tapping that money.
  • However, it may just be cheaper to cash out of the CD early, depending on the penalty charged by your bank or credit union for doing so.

As cash-strapped households look for cheap ways to borrow money, one alternative from some banks and credit unions may hold appeal: a loan against your certificate of deposit.

While these CD loans generally come with a lower interest rate than other options for quick cash — such as credit card advances or personal loans — it's worth weighing their pros and cons.

"If your CD has a severe early withdrawal penalty and other borrowing options have high interest rates, a CD loan might make sense when all things are considered," said Ken Tumin, founder of DepositAccounts.com. "But the best option is to use cash [instead of borrowing], if possible." 

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As the coronavirus-induced economic crisis has led to business shutdowns and stay-at-home orders, roughly 26 million people have filed for unemployment over the five weeks ending April 17.  

While the stock market has taken a hit and selling now may lock in losses , CD owners may have a way to get low-cost cash without actually tapping the money that's tied up in the CD.

Generally, investing in CDs is a low-risk way to earn higher returns than you would in a regular savings account (although less than stocks).

However, you're also agreeing not to access the money in the CD until it matures after a set amount of time — say, one, three or five years. 

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During that stretch, the bank or credit union pays you interest. (At credit unions, a CD is technically called a share certificate, but operates in the same way). Right now, some five-year CDs are paying about 1.75%.

Typically, the longer-term the CD, the higher the interest. And if you cash out early, you typically pay a penalty, which varies among lenders.

At banks or credit unions that allow you to to take a CD loan, here's how it works:

Say you have $10,000 in a five-year CD that pays 1.5% in interest and you want to borrow against it. You'd be charged interest on what you borrow, at a set margin above the rate you're earning.

So in this case, say it's two percentage points higher: You'd be charged 3.5% on the amount borrowed against the CD. Yet because you continue earning 1.5% on the CD, the cost of the loan would effectively be 2%.

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The reason the option is generally much lower than other borrowing options is because the loan is secured by your CD — that is, the bank or credit union can take that money to cover the loan if you don't repay it.

"Any type of unsecured loan will be costly in terms of the interest if you can't pay it back quickly," Tumin said. 

For instance, credit cards come with an average annual interest of just over 16%, according to CreditCards.com. For cash advances, the average rate is above 21%, research from WalletHub shows.

However, keep in mind that it also might be cheaper to just tap the CD early, although it would disrupt whatever goal you had for the money. Depending on the amount of the early withdrawal penalty — which can be, say, three or six months' worth of interest — you might spend less than taking the loan.

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