A CD, or certificate of deposit, generally pays higher interest than a savings account. In return, you agree to tie up your money for a fixed period such as one year or longer. Like all good deals, there's a catch. You'll pay a penalty if you want to take out your money before the CD matures. A CD loan is a way to get cash before the maturity date without paying the penalty.
TL;DR (Too Long; Didn't Read)
A CD loan allows you to use the CD's funds as collateral for the loan.
Basics of a CD Loan
Most financial institutions only make a CD loan if you bought the CD from them. In many cases you can borrow as much as 95 percent of the CD's value. Banks usually prefer to give loans only on CDs with at least one year to maturity, at which time the loan also comes due. Your borrowing costs include loan fees plus interest, which is usually the CD interest rate plus 2 to 3 percent.
Many financial institutions offer flexible repayment plans. You can choose to pay back the entire loan amount plus interest before the CD matures. In this case, you keep your savings intact. Some banks also permit interest-only payments or principal-only payments. If you choose one of those options, the bank will take some money from your CD when it matures. If you like, however, you can roll over the CD and renew the loan at this time.
Advantages of CD Loans
CD loans provide a ready source of funds for a special occasion, such as an anniversary cruise or a wedding. A CD loan usually costs less in interest than a credit card loan and allows you to keep earning a high rate. Borrowers with poor credit can get CD loans, in many cases without a credit check and in as little as 10 minutes. You can even use a CD loan to add positive history to a weak credit report. Just ask your financial institution to report the repayment to the credit bureaus.
Disadvantages of CD Loans
You'll lose a chunk of your hard-earned savings if you fail to pay back both principal and interest before your CD matures. It's also usually a better deal to cash the CD and pay the penalty, according to Jane Bryant Quinn, author of "Making the Most of Your Money Now." Add up the after-tax interest you'll forgo and the penalty for cashing early. Compare that to the loan origination fee plus the total interest for the loan. In most cases, Quinn recommends cashing the CD if it's cheaper. However, she recommends making the loan on a large, inherited CD that you couldn't replace through savings.