What is a CD? The traditional certificate of deposit is a set amount of money for a length of time and earns a set interest rate. "A certificate of deposit is a type of savings account. The bank agrees to...
"A certificate of deposit is a type of savings account. The bank agrees to pay interest if the deposit is held at the bank for a set period of time. There are usually penalties if the money is withdrawn before the maturity date of the certificate," says Sharon Lee, the Executive Vice President and Director of Client Services of American National Bank, who has thirty years in the banking industry.
The Federal Deposit Insurance Corporation or FDIC insures them up to $100,000 per person. Standard time frames are from three months to five years. If you pull money out of a CD before the maturity date, you will pay heavy penalties, sometimes even going down into the principle amount. Therefore, you want to be sure the money in a certificate of deposit will not be needed if possible.
The traditional certificate of deposit is a set amount of money for a length of time and earns a set interest rate. This is the original and most popular form of a CD. Almost any financial institution sells them. Some banks will allow you to add money to the CD during the term or if you decide to roll it over into a new one after maturity of the original. "Higher rates of interest are normally paid for longer maturities. These terms allow the bank to effectively manage their deposit portfolio and ensure they have sufficient funds on hand to meet customer demands," said Sharon Lee.
Many financial institutions in an attempt to gather and keep business have created several new nontraditional certificates of deposit. You pay for the greater flexibility of the CD by having a lower interest rate. Know the rates, terms and penalties before purchasing a CD.
One new type of CD is called a bump-up. This is a great choice if the economy is showing signs of rising interest rates. For example, you purchase a thirty-six month certificate of deposit at a fixed rate that may be a little lower. Twelve months into the term, the bank decides to offer an additional one-half point of interest on thirty-six month CDs. You have the option now to have your original CD bumped up to the new rate for the remaining time. Typically, this is a one-time chance during the original term.
A liquid certificate of deposit allows the purchaser to withdraw some money from it without any penalties. As a guarantee for the bank, a minimum amount may be required to stay in the CD. Once again, you may sacrifice some on the interest rate, as it will be lower than a traditional CD of the same term. Be sure to know how soon after opening the CD that you can make a withdrawal and how many withdrawals you can make during the term.
A callable certificate of deposit is one that the bank can 'call' away from you before it matures. This means that after the 'callable' time period, the bank can take the CD and reissue it at a lower interest rate. You still receive your full principle and any interest earned during the non-callable period. This option is a risk, especially if the economy is showing signs of inflation and the Federal Reserve lowers the prime rate. However, to counter the risk, the bank may offer a slightly higher interest rate on this type of CD.
