What Is A CD (Certificate Of Deposit)?

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A certificate of deposit (CD) is a low-risk savings account that earns a fixed rate of return. In exchange for this guaranteed yield, you agree to lock up your funds until the CD expires. CDs are best used for money you no longer need before they expire. If you access your funds before then, you will incur an early withdrawal penalty.

What is a CD?

A CD is a type of account offered by banks and credit unions that pays interest on your money over a set period of time. These accounts pay a guaranteed rate of return. CDs may offer a better annual percentage yield (APY) than traditional savings accounts, but the difference isn’t as great as it once was.

If you go to a securities company, you will find that they also handle CDs from various financial institutions.

How CDs work

CDs lock your money up for a set period of time in exchange for a guaranteed APY. Understanding all the features of a CD will help you decide if it’s right for you.

• semester: When you open a CD, you must choose how long the money will remain in your account. For example, if you open a CD with a one-year term, you agree to keep your money in your account for one year. At the end of the CD term, the CD matures and you can withdraw your money or renew the CD.
• Early withdrawal penalty: Early withdrawals from traditional CDs can result in severe penalties that eat up your interest income and possibly some of your principal. The longer a CD is used, the more expensive it tends to be. Fees are typically calculated based on interest for a specified number of days.
• AP: APY is the rate of return on a CD. The higher the APY on a CD, the more interest you earn. CDs typically compensate for less flexibility compared to high-interest savings accounts.
• Minimum deposit amount: Some banks don’t require a minimum deposit when opening a CD, while others require $500, $2,500, or more. Unlike a savings account, once you open a CD, you can’t add more funds to it.
• Grace period: When your CD matures, your bank will give you time to withdraw your money or roll it back into a new CD. The grace period is often 5-10 days. If you don’t make any changes during the grace period, most banks will automatically roll your balance into a new CD.

Why should I consider purchasing a CD?

CDs are a low-risk place to store your cash and provide a guaranteed rate of return. This makes it a good investment for short- to medium-term goals, such as buying a new car or saving for a down payment on a house.

It’s also a good place to store money that you don’t want to touch for a period of time, as there are usually penalties for making early withdrawals from CDs. You can also potentially earn more than a standard savings account.

However, CDs are not necessarily the best option for everyone or in every situation. The minimum deposit amount for a CD may be higher than the deposit amount associated with a savings account. If you need money urgently, CDs may not be the best option. In that case, it’s better to keep your money in a more liquid account, such as a savings account or a money market account.

Although CDs can earn more interest than savings accounts, they are still a low-risk investment, so they offer a lower yield than what you would get by putting your money in the stock market. To get a higher rate of return, aim for riskier investments.

How to choose a CD

If you think opening CDs is right for you, you might want to think long and hard about which CDs to open. Consider the following factors:

• CD terminology. Start by thinking about how long you want your CD to last. This is because it affects other aspects of the decision. Please note that your money is locked in the CD for the entire term. So, choose a time period that aligns with when you need your refund.

• Consider unique features. Some banks offer CDs with unusual features. For example, Ally Bank offers a “Raise Your Rate” CD that allows you to increase the rate of your CD once or twice during the term, as long as market rates have increased since account opening. Depending on your goals, some unique CD features may be appealing.

• Minimum deposit amount Banks usually require a minimum deposit before opening an account. Minimum values ​​can vary widely, and some banks have very high requirements. Before you get too attached to a particular CD, make sure you meet the minimum deposit amount.

• interest rate. Look for CDs with higher available rates based on your desired CD term, features, and minimum deposit requirements you can meet. Remember, the higher the APY on your CD, the more interest you can earn.

• Early withdrawal penalty. You shouldn’t plan on making early withdrawals, but if your two CDs are very similar, find out what the penalties are for each if you make an early withdrawal. Choosing an account with a lower penalty could potentially save you cash should the unexpected happen.

What happens to CDs as they age?

When a CD expires, it enters a grace period. This period is a period during which you have the opportunity to make changes to your account, such as withdrawing money, depositing more money, or rolling your balance into a new CD, either in the same period or in a different period.

Depending on the bank, the grace period for CDs is typically 5 to 10 days.

If you don’t make any changes during the grace period, your bank will typically roll your CD balance into a new CD with the same term as before. The interest rate on your new CD will be the current rate offered by your bank. The interest rate may be higher or lower than the interest rate on your previous CD.

Once the grace period ends and your bank opens a new CD, you will be subject to early withdrawal penalties if you make any changes. That’s why it’s so important to pay attention to your CD’s maturity date to avoid having your money locked up in your CD for longer than you planned.

Advantages and disadvantages of CDs

Strong Points

• Safety: CDs are Federal Deposit Insurance Corporation (FDIC) member banks and National Credit Union Administration (NCUA) insured credit unions with up to $250,000 per account holder, bank, and account type. It is insured.
• Predictability: You get a guaranteed rate of return.
• Higher APY: CDs can offer higher APYs than traditional savings or money market accounts.
• option: There are many different types of CDs available to suit different financial needs, and many duration options.
• availability: CDs are widely available from traditional banks, credit unions, and online banks.

Cons

• Liquidity: CDs are illiquid, so you have to keep your money there for a certain period of time.
• Penalties: CDs often come with stiff penalties if you withdraw your funds before the maturity date.
• risk: Some CDs, such as callable CDs, are more dangerous than other types. Early withdrawal penalties also pose risks.
• tax: You will pay taxes on the interest that accumulates on the CD during the term.
• Lower profit: CDs do not offer returns as high as other investments such as stocks or bonds.

CDs and savings accounts

Both CDs and traditional savings accounts can help you save money and earn interest, but choosing between them can be difficult. Each serves a different purpose.

• Savings accounts are good for storing funds that you need to access quickly. That’s because you can typically withdraw money from your savings account up to six times a month without any fees. For this reason, savings accounts are good for holding emergency funds or funds for very short-term goals. CDs, on the other hand, typically come with early withdrawal penalties if you need to access your funds before the term ends.
• CDs are a great place to store funds that you won’t need in the near future. Buying a CD locks in your funds, which prevents you from spending money on impulse purchases.
• A savings account’s APY can change over time, but a CD earns a fixed APY. Whether variable or fixed APY is better depends on your current rate environment. Floating interest rates are advantageous when interest rates are rising, while fixed interest rates are advantageous when interest rates are falling.

Finally, if you want quick and easy access to your funds, consider keeping your funds in a traditional savings account. If you have some money and can part with it for a certain period of time, consider buying a CD.

How to make a CD ladder

A CD ladder is a strategy that involves purchasing multiple CDs with different maturity dates. CD laddering reduces risk and gives investors regular access to cash while taking advantage of higher interest rates.

First, decide how much you want to save and how often you can access the money from your mature CD.

As an example, let’s say you want to build a 5-step 5-year ladder. If you have $5,000 to invest, you can place $1,000 in each tier. It will look like this:

In this setting, CDs mature every year, and CDs with longer terms are likely to provide the highest returns. However, this is not necessarily the case in the current CD rate environment.

One way to extend the ladder further is to repurpose funds from a recently matured CD into a new 5-year CD.

Build a CD ladder that fits your budget and schedule with Bankrate’s CD Ladder Calculator.

CD type

All types of CDs require you to store money for a specified period of time, but some CDs have additional features and flexibility. The different types are:

Frequently asked questions about certificates of deposit

conclusion

Overall, CDs are a safe investment offered by banks and credit unions with a guaranteed rate of return. They require you to keep your money for a certain period of time, but in exchange, they often earn higher interest rates than traditional savings or money market accounts.

In a high-rate environment, the benefits of saving money on CDs are even greater, and you’re guaranteed to earn that high rate for the duration.

–Freelance writer TJ Porter Contributed to updating this article.