A Certificate of Deposit (also known as a CD, COD, or Time Account) is a financial product that usually pays a fixed interest rate for a set period, ranging from a few months to several years. This period is known as a “term.” Below are six things to know about CDs when deciding where to keep savings.
1. CDs are different from savings accounts
Savings accounts give regular access to your money as you can deposit and withdraw anytime. CD accounts operate under the assumption that you won’t withdraw until the CD matures. When you withdraw early from most CDs, you pay a penalty of several months to a year’s interest. CDs also tend to have higher rates than regular savings accounts, depending upon CD’s terms. If you open a CD when interest rates are high, you can enjoy that rate even if banks drop rates on savings accounts and new CDs.
2. Opening a CD account is easy
Opening a CD starts the same way as for other bank accounts. You can apply online or in person at a financial institution. The difference is that your initial deposit into a CD will almost always be the only deposit you can make. You can’t add contributions over time like you can with regular savings or checking accounts. Depending on the bank or credit union, you’ll also have to choose a CD term ranging from as little as 28 or 30 days up to 10 years or more.
3. CDs are insured
Certificates of deposit are insured, so you get your money back in the unlikely event your bank goes bankrupt. The Federal Deposit Insurance Corp (FDIC) insures CDs at banks. The National Credit Union Administration insures certificates at credit unions. Your funds are federally insured up to $250,000 per account at banks and credit unions.
4. Interest in CDs is compounded
The interest earned in a CD is usually compounded and credited to the account, either daily or monthly, and you receive it all when the CD term ends. CD rates are in terms of annual percentage yield, or APY. This is the annual interest rate after compounding. As a rule of thumb, the longer the CD term, the higher the interest rate you can earn. Some banks or credit unions may, however, offer promotional CDs that feature higher rates with shorter terms. According to Federal Deposit Insurance, the national average rate for a regular savings account is 0.30%, far below the average rate for a five-year CD of 0.98% annual percentage yield.
5. Choosing CDs depends on your savings goals
If you have money set aside for a large future purchase, a CD can be an excellent way to keep it safely out of reach and let it earn interest. Choosing between short- and long-term CDs comes down to balancing the rates and length of time you want to commit. Traditionally, the longer the term length, the longer you commit funds to a CD, and the higher the interest rate. You might also join a bank or credit union outside your primary financial institution if they offer better CD rates.
6. There is a grace period when CD matures
When a CD matures or expires, there’s a grace period of about a week to withdraw funds. Once a CD matures, you can withdraw the money you have saved and the interest earned. However, it’s important to note that many banks typically renew your CD at a new rate, which tends to match that of new CDs for the same period.
Conclusion
A CD with a reasonable rate can play an important role in your overall savings plan. Investing in a CD isn’t the quickest way to grow your money, but it offers a guaranteed return and safety that money in the stock market doesn’t have. By choosing the right type of CD and avoiding withdrawal penalties, you can earn a solid return on your money while having your savings backed by the federal government.
Key Takeaways
- CDs are different from savings accounts
- Opening a CD account is easy
- CDs are insured
- Interest in CDs is compounded
- Choosing CDs depends on your savings goals
- There is a grace period when CD matures
