Back in the day when I was new to banking and I first heard about people taking out loans secured by their own bank deposits it seemed, well, illogical. If a borrower already has the money, why does he need to borrow at all? It’s a good question, and sometimes the answer is that it is better just to use the money on hand and not borrow. There are circumstances, however, in which borrowing against one’s own money on deposit makes perfect sense, even to Mr. Spock.
The question goes back to the dilemma that a person or a business has in managing cash reserves. Holding cash in a demand account is costly, since it earns no interest and tends to depreciate in value over time through inflation. Investing in a bank CD, bond, mutual fund, or other investment makes cash less available in case of need. A CD may have an early withdrawal penalty, and other investments may have market risks and transaction costs. One might be willing to trade off liquidity for earnings, but what if the funds are needed for a contingency or to take advantage of an opportunity?
This is where putting money to work in a longer term CD comes in. I wrote in an earlier blog post about overcoming fear of commitment and investing in longer term CDs. I explained how today’s low deposit rates can translate into low early withdrawal penalties. But another way of efficiently accessing needed funds from a longer term CD is by borrowing against it. Here are some scenarios where CD secured loans pass the logic test:
- You don’t think you will need to use your money, but you want to have it available for unforeseen contingencies. You can put your money to work earning some interest, but can easily and quickly borrow against it if the need arises. Our bank typically prices CD secured loans at only 2% over the CD rate. You can borrow as much as you like up to the balance of the CD without having to cash in the deposit or pay an early withdrawal penalty.
- You have seasonal cash flow fluctuations, and secure a line of credit with a CD. Again, the interest cost will be low, and you won’t have to report your receivables or provide other information to the bank as you might if the loan were secured by other types of collateral.
- You need a standby letter of credit, which will most likely never be funded, but which must be collateralized. Securing the letter of credit with a CD makes underwriting and approval of the facility quick and easy.
- You are a guarantor on a commercial loan made to a business entity. You can pledge your personal CD to the corporate debt, facilitating approval and lowering the cost of credit.
Sometimes there is another reason, more psychological than financial, to borrow against deposited funds. It is more difficult and requires more discipline to replace savings that have been spent than to make the scheduled payments on a loan. This also has a certain logic. The discipline of the payment schedule may well be worth the cost of borrowing.
Higher deposit rates make it more logical to borrow against a CD, and rates are finally edging upward. Economists have proven that if you predict higher rates long enough, it will eventually come true! If this trend continues, the value of money on deposit will increase, and putting cash reserves to work will make even more sense. You can always access funds in case of need with a CD secured loan.
Business Bank of Texas offers competitive rates on CDs and Money Market deposits. We also offer CDARS CDs and Insured Cash Sweep accounts that can provide you with FDIC deposit insurance on balances greater than the basic $250,000 per person limit. Contact one of our business bankers to find out more about all of our commercial credit services, or call Ivonne Villegas at 512-835-6600 to learn about our deposit and cash management services.