What are CD’s?
CD’s are actually are technically referred to as “Certificates of Deposit” and are a time deposit, financial product typically offered by banks, credit unions, and thrift institutions. They are similar to a standard savings account in that they are insured by the Federal Government. They are insured by the FDIC if issued by a bank and the NCUA if they are issued by credit unions. Additionally, they are literally a risk-free form of investing or saving money.
However, there are some basic differences between CD’s and standard savings accounts such as having a fixed term of 3 months, 6 months, or from one to 5 years, featuring a fixed rate of interest and should be held until they mature when you can withdraw the funds along with any interest that has accrued.
Due to the fact that these should not be withdrawn on before they mature or reach the end of their term, financial institutions typically pay a higher rate of interest on these compared to standard passbook savings accounts.
CD interest rate guidelines
There are several different guidelines that are typically followed where the interest rate on CD’s are concerned. These include banks and credit union who offer CD’s that are not insured by either the FDIC or NCUA (respectively) typically offer higher rates of interest. Larger principals should pay a higher rate of interest but not all of them due and longer terms normally involve higher rates of interest except if there is an inverted yield curve (typically precedes a recession). Personal CD’s typically receive a higher rate of interest compared to business CD’s and smaller financial institutions tend to offer higher rates of interest than the larger ones.
How CD’s work
CD’s usually have specific deposit requirements and may afford you a higher rate of interest on larger deposit amounts. In the US, “Jumbo CD’s”, those CD’s that typically have a $100,000 deposit minimum or larger, pay higher rates of interest. Just be aware that this is not a standard rule of thumb with all financial institutions that offer Jumbo CD’s. Ironically, even though they are technically called Certificates of Deposit, there is no actual “certificate” that comes with the account. Account activity is usually monitored by virtue of a passbook and a monthly statement.
Where the payout of interest is concerned, account holders usually have the option of receiving the interest in the form of a check or deposited into a checking or savings account. Just remember that the interest needs to be accounted for when filing your taxes. The downside is that there will be no compounding since you are withdrawing the interest so the yield is ultimately reduced.
When it comes to closing a CD before it reaches maturity, be aware that the partial or total withdrawal will be subjected to penalty fees. As an example, withdrawing the funds from a 5-year CD will usually result in losing 6 months worth of interest. The penalties that arise are a way of letting the account holder know that early withdrawal is not in their best interest and should be avoided.