Certificate Of Deposit Loan: A Secured Bank Loan Perfect For An Emergency

June 12th, 2009

What’s a Certificate of Deposit Loan?

It sometimes happens that we find ourselves in a position where we need a loan to pay off bills and we need a good chunk of money to solve the problem; the problem, though, is not the money, it’s that the money is at the bank in the form of a CD (certificate of deposit). Most people just suck it up and pay the early withdrawal fee (which can amount to up to six months of interest), probably because they don’t know that they have the option of getting a certificate of deposit loan. A certificate of deposit loan is a secured bank loan where the owner of the certificate of deposit account is allowed to avail a loan based on the existing CD as collateral.

What Are Certificates of Deposit?

Certificates of deposit, also known as a CDs, are an investment instrument that provides mid to long-term stability and are one of the best ways to save money and earn a decent profit from interest income. CDs are typically fixed rate, in other words, the investor and bank agree upon an interest rate at the opening of the account, and this rate stays constant until the CD matures. Stashing a few certificates of deposit in your portfolio is also a good way of investing cash, as long as you hold them to maturity.

Investing in a CD means locking in your savings for a set amount of time, usually three months to five years, and in this time span, you’re paid interest based on the terms you agreed on when you opened the account. However, there are certificate of deposit arrangements in which consumers can choose to hike up the interest rate one time during the term of the investment. Like savings and checking accounts, CD’s are protected by federal deposit insurance up $250,000, and are thus pretty safe investments.

A certificate of deposit boils down to what is known as a promissory note. This means you are giving the bank this money which they may use to make a profit obviously and then return the money back to you once the term has been served.

Why Get a Certificate of Deposit Loan?

The main problem, though, with a CD is that for the duration of the contract, your money is locked and you can’t get access to it. A certificate of deposit can be broken, and money asked back before the due date, but this will incur a penalty so it is not the wisest choice. Early withdrawal penalties for CDs usually come in the form of losing interest. Depending on the conditions of your CD, you might have to pay 30 to 90 days worth of interest if you take money out of a 12-month or less CD early. Longer term CDs typically may have even stiffer penalties.

The second-best choice is a savings accounts, where your money is available to you anytime you need it, but the interest rate is significantly lower than what a comparable CD would pay. As previously stated, in the case of a CD, if you draw your funds early, you pay a penalty, known as an early-withdrawal fee. If you got your CD from a broker who may have told you that there is no early-withdrawal penalty, you can still lose money with an early withdrawal.

Here’s why: brokered certificate of deposits are an entirely different animal when it comes to early withdrawal penalties. With a brokered certificate of deposit, you purchase a CD from an investment bank, you don’t pay an early withdrawal penalty but if you want your funds before the CD matures you have to sell it at the current market rate by requesting bids on your CD. You can benefit from this only if interest rates are lower when you cash your CD than they were when you bought it. It is so because an investor will be willing to pay more for your CD if the interest it pays is higher than what the market is offering. If you sell, you’ll receive the bid price plus any accrued interest but there are no guarantees that you’ll get what you originally paid for the CD. Let’s do the math:

If you have a three-year CD at 5.5-percent interest and you want to sell at a time when the highest rate on a three-year CD is 4 percent, you’ll get a premium for your CD. But if you’re strapped for cash and have to sell when the current best rate on a three-year is 6 percent, there’s less demand for your CD and you may have to sell it at a discount. The money you lose could be actually greater than the early-withdrawal penalty you’d pay if you had purchased the CD through a bank. You could even lose an amount equal to your original deposit. That’s where a certificate of deposit loan might come in handy.

How a Certificate of Deposit Loan Works

Like we said before, a good way to avoid paying early-withdrawal fees is to get a certificate of deposit loan. As its name suggests, a certificate of deposit loan is a loan that is granted to you based on the fact that you have a certificate of deposit to offer the bank as collateral. If you had opened up a CD and are in need of money for an emergency, remember that you still have options. Instead of paying the early-withdrawal penalty, explore the option of borrowing against those funds instead by getting a certificate of deposit loan. You’ll have the double benefit of getting low interest rates from the bank (because the risk it takes is minimal) and still have your money earning interest (because your CD is still open). Depending on the financial institution, your credit history, and your relationship with them as a customer, you can get terms up to 60 months and borrow up to 100% of the CD’s face value. For a fixed dollar amount and a specified time period, a certificate of deposit loan may be arranged for nearly any project or purpose and you’ll continue to earn interest on your account while you’re enjoying the benefits of your new loan.

Before you dip into your savings or pay the penalty because of early withdrawal of funds from a CD, consider borrowing against those funds instead. You can borrow at low rates while the savings that you so diligently set aside will continue to grow. This (apparently little-known) money management tool may make sense for you.