Building savings and establishing credit are important, especially for young people just starting careers, often with a load of college debt. You can use certificates of deposit in both elements. A CD will pay you a higher rate of interest than a checking or regular savings account because the financial institution is assured of having that money on deposit for a fixed length of time. A CD also is a safe investment, insured by the Federal Deposit Insurance Corp. It will be an asset on your credit report and also can be used to build a good credit history.
You can use a CD to build good credit history by borrowing against it. Institutions typically will loan up to 95 percent of the value of the CD, so you could borrow $950 on a $1,000 CD. When that's paid off, at the end of the CD term, it will show on your credit report as positive for your credit history. You must make sure, though, that the institution reports it to the credit rating agencies. Institutions usually will report such payoffs, but you should double-check with the institution making the loan to be sure.
Help Your Score
Using a CD for even a small loan also can affect two other elements of your credit score: new credit and types of credit used. Those account for about 20 percent of your total credit score. A CD-secured loan will be a positive for demonstrating new creditworthiness and the type of credit; a secured loan is always better than an unsecured one for your credit rating.
Get Better Rates
A CD helps you get better interest terms for a loan. The interest charged by an institution on a CD-secured loan will be a bit more than the interest being paid on the CD, but that still be will less than interest paid on an unsecured loan. If your CD is earning 2 percent and the bank charges you 3 percent for a loan, your effective interest is only 1 percent.
Know the Limits
There are limitations on a CD for credit. You can only borrow against it with the same institution that issues it, you're limited in what you can borrow by the amount of the CD and a CD-secured loan is tied to the length of the CD. A $5,000 CD won't get you a $10,000 car loan, for instance, and you can't get a three-year loan on a one-year CD. You might be able to extend the length, though, by rolling over the CD into a new one.
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- How to Invest in High-Yield Certificates of Deposit
- How to Calculate the Interest Rate on a CD
- How Much Return on My Investment Do I Get on a CD?
- Rules for Transferring IRA Certificates of Deposit