A certificate of deposit, also known as a CD, is a time deposit offered by most banks and financial institutions. Although they share a likeness with savings accounts being that they are risk-free investments. The difference is that certificates of deposit have a fixed term, usually anywhere from a few months to five years, and have a fixed interest rate. The intention of the CD is that it can be held until maturity before withdrawal.
For a bank to stay in business, they need to loan out money and then get it back, along with a high-end interest rate. For some customers, whose credit score clearly dictates a lower than average interest rate, CD’s provide the prime opportunity for banks to do business with these customers.
CD’s are ordinarily purchased through banks and local credit unions. Some brokerage firms, “deposit brokers,” as well as traditional stock brokerage firms can often negotiate a higher level of interest for a CD than that of another financial institution. These are often referred to as “brokerage CD’s.” This is often the case when the size of the CD exceeds $100,000, often called “jumbo CD’s.” It’s also important to know where, in fact, the money is being deposited.
It’s essential to know exactly when the CD will mature. Some people fail to get a grasp on this concept, and are amazed to find that their money is tied up for what could be nearly twenty years. The maturity rate of any CD should be noted in the contract. Also be aware of the fact that an institution may “call” a CD; basically terminate it if the interest rates fall. You, as the buyer do not have that luxury.
Inquire about whether or not the interest rate will change. Sometimes CD’s feature a “bonus rate” or “multi-step” model that will increase or decrease the interest rates according to a predetermined date. Check with the provider to find out the penalty for an early withdrawal.
It is also a good idea to become intimately familiar with the institution who is issuing the CD. Banks operate on several different levels and their financial strength may need to be investigated. Contact your local FDIC office for information about any brokerage or lending institutions that you may be planning to do business with. As with any endeavor, especially financial, it is best to do a good amount of homework before committing to a working relationship.
With most financial institutions, there is a one week, or seven day period after the purchase of a CD for the holder to review it and return it if they are in any way unsatisfied with it. Once the maturity rate is securely locked in, the holder has the CD unless it can be sold by the broker.
It was once said that CD interest rates reflect the current rate of inflation. Though this was thought to be true at one point, it has now been proven false. During a credit crunch, banks will raise the interest rates well above that of current inflation.
More From This Contributor
First Person: Frugality Cut My Grocery Bills in Half
Personal Finance Basics During Financially Difficult Times
Get That Job You Want: Interview Mistakes to Avoid