17 Things to Know About Certificates of Deposit (CD's)
Written by: Kristy Welsh
Last Updated: August 19, 2017
Though certificates of deposit are among the most basic of investment options, that’s not to say they should be entered into blindly. As with any place you plan to put your hard-earned money, the more you know about CDs, the better. Here’s a good place to start.
1) What is a certificate of deposit (CD)?
A CD is a certificate you receive from a bank or credit union in exchange for an interest-earning deposit you’ve made with them – and agreed to keep there – for a specified period of time.
2) What are CD terms?
A CD term is the amount of time you agree to keep your deposit account open. These terms vary, from as little as 1 month up to 20 years. The availability of terms depends on the institution from which you choose to open your CD account. The most common terms are 6 months to 5 years.
3) Which is the best CD term to choose?
It varies according to circumstance.
For instance, you typically see higher interest rates on longer term CDs. However, you’re probably better served choosing a shorter term (i.e., one with lower interest rates) if you know you may need to access the cash sooner than later.
That said, even if you know you won’t need the money for years to come, signing on to a shorter term CD may be more lucrative in the long run.
For instance, interest rates may rise while your money is tied up in a fixed-rate CD. The shorter the term, the sooner you can cash out that CD and open a new one at the higher interest rate.
4) Are there different types of CD options?
Yes. There are several types of CD options to choose from, like:
- Traditional, fixed-rate CDs
- Variable-rate CDs
- CDs with low or no penalty for early withdrawal (but at lower interest rate)
- Callable CDs, the terms of which the bank can change at any time (but at higher interest rate)
- Bump-up CDs allowing you to “bump up” to a higher rate once per term (but at lower initial interest rate)
- Indexed or structured CDs, which are linked to other types of investments
5) Can I take my money out of a CD before the term ends?
Yes, you can, but for a price. You’ll pay a penalty for early withdrawal and, in some cases, you may even lose part of your initial deposit.
6) Are CDs federally insured?
Yes. CDs issued by a bank are FDIC-insured; CDs issued by a credit union are NCUA-insured.
7) Why would I choose a CD over other types of investments?
CDs are low-risk investments that allow you to earn more than you normally would through a regular savings account.
8) Why should I think twice about putting my money into CDs?
CDs are low-return investments that may barely earn enough to keep up with inflation.
9) What is a CD ladder?
Building a CD ladder means investing in a number of CDs with varied term lengths, ranging from 1 to 5 years, for example. This way you can take advantage of higher interest on a 5-year-term CD while spreading the rest of your investment over shorter terms. In this way, you always have money coming available to you, either for cashing out or reinvesting into a longer-term CD.
10) How do I open a CD account?
You may go through your current bank or credit union, but it’s a good idea to shop around, compare rates, and read the fine print. Be sure to include local banks and online banks in the mix. You may also go through a “deposit broker,” but they will still be opening the CD account with a financial institution.
11) Is it a good idea to open a CD account through a deposit broker?
Deposit brokers are brokerage firms or independent salespeople who open CD accounts on your behalf. You may find that these options offer higher interest CDs, but it may also be more costly, for example, to close your CD account early, as you may lose part of your principal.
Before going with a deposit broker, ask for and read carefully the terms of the agreement and, most importantly, compare it to others offered directly through a bank or credit union.
12) Where can I go to compare CD interest rates?
There are a number of online websites where you can compare the best CD interest rates on any given day, like Bankrate and NerdWallet.
13) What do I need to be looking at when shopping around for a CD?
Before you sign on the dotted line, do your homework. That means comparing CD options across multiple banks and/or credit unions. Be sure to look at:
- Disclosure statements
- Interest rates
- Term lengths (make sure you see the maturity date in writing)
- Early withdrawal penalties
- How you’re paid interest
- How often you’re paid interest
14) Should I always choose the highest interest CD option?
Not necessarily. The CDs with the highest yields are typically those with the longest terms. Unless you are certain you will not need access to that cash until the CD has reached maturity (i.e., the length of the term), go with a lower-interest, shorter term option.
15) Why do CDs pay higher interest rates than regular savings accounts?
Banks and credit unions pay higher returns on CDs because you are guaranteeing them use of your money for a guaranteed period of time. Savings accounts offer these institutions no such guarantee.
16) How often is a CD’s interest compounded?
Interest on your CD may be compounded daily, monthly, quarterly, or yearly depending on the bank or credit union.
17) What happens to my CD once it reaches maturity?
You may have the CD renewed for the same term length, open a new CD under new terms, or cash it out. Just be sure to make your decision before the renewal date. Otherwise, the CD may be automatically renewed for you.