A certificate of deposit (CD) is an investment tool you can purchase at a bank. Many people choose CDs because there is very little risk in using them, but it also means that the rate of return may be lower than other investments. When you put your money in a CD, you agree to leave it in the bank for a set period of time or you will forfeit all the interest you earned.
A standard CD will lock in a set interest rate for the life of the CD. This can protect you if the market drops, but it will lock your money in at a lower rate if interest rates were to rise. The interest is paid on a regular basis, generally quarterly. Most CDs allow you to choose to have the interest added onto your CD or for you to get a payment for the interest earned. There is generally a high minimum balance of at least $1,000 to open a CD. CDs with better rates may require a higher minimum balance. If you withdraw the money early, you will lose any interest you have earned up to that point. You may also incur other penalties.
Variable Rate CDs
A variable rate CD has a rate that will change throughout the year; generally, the rates change quarterly. However, your bank may have another schedule it follows. When and how often the rates change should be listed in the information you receive when you open the account. A variable rate CD is usually tied to a Treasury bond or another security, and will adjust to match that rate. This means the rate may adjust up or down depending on market conditions. The same rules for a standard CD regarding early withdrawal and interest payments apply to a variable rate CD.
CD Called In
Your bank may have the option to call in a CD early. This does not mean the CD matured, but they no longer want to have the CD at the rate originally offered. They will notify you if your CD has been called, so you can decide what to do with the money. This protects banks if you locked in a good interest rate, but then the rates dropped drastically. Only the bank has the option to call a CD in; you must wait until the CD matures or you will incur the penalties listed on your deposit agreement. Some confuse the maturity date with the call in option; be sure to read the agreement carefully to avoid doing so.
Considerations When Choosing a CD
A certificate of deposit is a good savings option if you know you will not need the money in a set period of time. However, if you are not sure when you will need the money, you may consider other options because of the penalties you will receive for early withdrawal. A CD can be protected under the FDIC, but you must take in to account how much money you already have at that bank. A customer service representative should be able to look over your accounts to see if the money will be insured.