Eyeing a CD? Here's the Lowdown
A CD, or certificate of deposit, is a financial instrument issued by a bank or other financial institution, which involves the deposit of a fixed amount of money for a specified period of time in exchange for a guaranteed interest rate upon maturity.
A CD (Certificate of Deposit) is like a special savings account that's got a guaranteed rate of return on your dough. In exchange, you agree to let it ride for a set period (the term). Popular terms range from as little as three months to as long as five years, but they can go shorter or longer too. Keep in mind, when choosing a term, think about when you might need access to that cash.
So, what happens if you need that money before the CD's term ends? Well, you'll likely have to pay an early withdrawal penalty. This penalty chews into the interest (and sometimes the principal too).
How do CDs work?
Ain't no party like a CD party because these puppies operate differently from regular savings accounts. You usually can't add money or make withdrawals at will, but you do get a fixed rate of return. Here's the lowdown on all CD features:
- Term: Every CD's got a term, which is the length your money stays put, earning interest. Terms can be as short as one month or as long as 10 years. And once your term's up, you can choose to renew the CD or take your funds and run.
- Early withdrawal penalty: Most CDs invest you with an early withdrawal penalty if you dip into your funds before they mature. This penalty is calculated based on a certain number of days' worth of interest and the number can vary based on the bank's policy and the CD's term length.
- APY: The APY (Annual Percentage Yield) is your CD's rate of return, and it's usually fixed. Unlike traditional savings accounts, CDs can offer higher rates due to the savings from customers leaving their money untouched. You can use a CD calculator to figure out exactly how much interest your CD will earn during its term. The higher the CD's APY, the more interest it'll earn.
- Minimum opening deposit: Unlike savings accounts, you gotta have some cash saved to deposit when you open a CD. Some banks don't require a minimum deposit, while others might ask for amounts like $500, $2,500, or more.
- Grace period: When a CD matures, you'll enter a grace period where you can withdraw your funds or roll them into a new CD. Most banks offer a grace period between five and 10 days. If you don't make any changes during this period, your CD will be automatically renewed.
Where can you open a CD?
CDs are offered by banks and credit unions, but credit unions often call them share certificates. You can also grab a CD via a brokerage firm. These are bank-issued CDs sold on the secondary market through brokerages. Though they look like traditional CDs, brokered CDs can be sold before they mature.
Are CDs insured?
As long as the bank or credit union offering the CD is insured by the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Share Insurance Fund (NCUSIF), you won't lose your money if the bank or credit union goes belly-up. FDIC-insured deposits are protected up to $250,000 per depositor, per insured bank. The same protection applies to NCUSIF-insured credit unions.
Should you consider a CD?
A CD can be a smart move when you're trying to stash cash for a future purchase, like a car or a home down payment. The penalty for tapping your funds early can be a good deterrent for impulsive spending. You might even score more than you'd get with a regular savings account.
However, a CD isn't the best home for emergency cash. You're better off keeping that dough in a liquid (preferably high-yield) savings or money market account. And minimum deposits for CDs can be steeper than those for other savings accounts, making it trickier for some folks to open one.
So, wanna learn more about CDs? Check out our picks for the best high-yield savings accounts.
How much cash do you need to activate a CD?
Minimum deposit requirements for CDs vary from bank to bank, with some banks not requiring a minimum at all. Online banks like Ally and Synchrony have no minimum, while others, like LendingClub and Popular Direct, may ask for a couple grand or more. Whatever you plan to tuck away, remember: use cash you don't need for living expenses or emergencies.
Before committing the cash, build an emergency fund in a liquid (preferably high-yield) savings account. Wanna get serious about CD strategy? Consider building a CD Ladder.
Types of CDs
Before choosing a CD, do your homework. Although all CDs share a common thread – stashing money away for a set term – some come with extras or more flexibility. Check out types like traditional CDs, no-penalty CDs, jumbo CDs, bump-up CDs, step-up CDs, zero-coupon CDs, callable CDs, and IRA CDs.
Picking the Right CD
Got your eye on a CD? Consider these factors before you commit:
- CD term length: Think about the right term length based on when you'll need access to your funds. Time your choice with your financial goals, such as planned purchases.
- Unique CD features: Occasionally, banks offer specialty CDs with flexibility, like bump-up CDs that allow you to boost the CD rate if rates rise during the term or no-penalty CDs that let you make an early withdrawal without a penalty.
- Minimum deposit: Make sure you can meet the minimum deposit required by your chosen CD.
- Interest rate: Compare interest rates for the terms you're considering and choose a competitive APY.
- Early withdrawal penalty: Consider the early withdrawal penalty of any CD you're thinking about. If two CDs are similar and one offers a lower penalty, you might choose that one to save some cash in case of an early withdrawl.
What happens when a CD matures?
When a CD matures, it enters a grace period. During this time, you can withdraw the funds without a penalty or renew the CD. The grace period usually lasts between five and 10 days, depending on the bank. If you don't make a move during the grace period, the bank will likely renew the CD with the same term, earning whatever APY they're offering for that term now. Remember your CD's maturity date, especially if you need the funds, because withdrawing after the grace period expires means you'll owe an early withdrawal penalty, and the renewed CD might not earn a great APY.
Pros and Cons of CDs
Pros
- Federally insured (up to $250,000).
- Fixed interest rate and predictability.
- Higher APYs than traditional savings or money market accounts.
Cons
- Limited liquidity.
- Penalty for early withdrawal.
- Risk that rates on new CDs will go up during your CD's term.
- Lower returns than other investments, like stocks (but also less risk).
CDs vs. Savings Accounts
Both CDs and traditional savings accounts help you save, but each is best used for specific purposes. Everybody should have a savings account for emergencies, but not everyone needs a CD.
- Savings accounts are for easy access to funds. They're great for emergency situations or short-term goals.
- CDs are for funds you don't need in the near future. They help keep you from temptation spending, making them a good spot for future financial goals.
- Savings accounts let you add funds gradually, while you commit cash to a CD. Once you deposit money into a CD, it stays there until the term ends.
- Savings account APYs change based on market conditions, while CD APYs are fixed. It's better to have a fixed rate in a rising-rate environment, while a variable rate could be advantageous during a falling-rate period.
Building a CD Ladder
If you're unsure about the appropriate CD term length, consider building a CD Ladder. This strategy involves opening multiple CDs at once, each with a different maturity length, to benefit from higher yields on longer-term CDs while freeing up some funds with shorter-term CDs. Determine how much you'd like to set aside and how often you want funds to become available. For example, you could place $1,000 in each rung for a five-year ladder with five rungs. When each CD matures, you can choose to extend the ladder, use the funds, or reinvest the money in a new CD. Use our CD Ladder calculator to help create a CD Ladder tailored to your budget and timeline.
- For individuals seeking a predictable return on their savings, money market accounts and savings accounts might be more suitable than CDs, as they offer more liquidity and flexibility for withdrawing funds.
- If you're particular about earning a higher interest rate on your long-term savings and can tolerate limited access to your funds, then a CD could be a viable option for your personal finance strategy.
- In the realm of business finance, brokerage firms can provide access to a variety of CDs and share certificates offered by banks and credit unions, allowing businesses to diversify their investments.
- When considering various types of CDs, including traditional CDs, no-penalty CDs, jumbo CDs, bump-up CDs, step-up CDs, zero-coupon CDs, callable CDs, and IRA CDs, research their unique features, minimum deposits, and interest rates to choose the one that best meets your financial needs.
- If you value the predictability and higher rates of return that CDs offer, yet also desire some liquidity, you might want to explore the strategy of building a CD Ladder – which involves opening multiple CDs with different maturity lengths – to enjoy the benefits of both short-term and long-term CDs while maintaining flexibility in your personal finances.
