How Certificates of Deposit (CDs) Work

Certificates of deposit (CDs) are among the safest investments available from banks and credit unions. They typically pay higher interest rates than savings accounts and money market accounts, but there’s one drawback: You have to lock up your money in the account for a specified period of time. It’s possible to get it out early, but you’ll most likely pay a penalty.¹

How Does a CD Work?

A CD is a form of “deposit for order”. In exchange for a higher interest rate, you promised to keep your money in the bank for a fixed period of time. The Bank agrees to pay you more interest than you would earn on a savings account in exchange for this Agreement. You’ll get a higher annual percentage return (APY) on your deposit because the bank knows you can use your money for long-term investments, like borrowing, and won’t ask for it next week.

NB
It’s up to you how long you want to hold your money while opening a CD. This period of time is called a word.

CDs come in many different forms, and banks and credit unions continue to offer new options. Historically, CDs came with unchanged fixed prices, and you always pay a penalty if you leave early. But that is no longer the case.

How to get started with CDs
Call your bank or credit union if you choose to open a CD with a local financial institution. Most banks explain your options and allow you to invest in CDs online. You can also call customer service or talk to my banker in person.

Explain the amount you want to invest and ask about early withdrawal penalties and other CD features. The bank may have additional CD options that may be better for you. They may offer higher prices, greater flexibility, or other features.

You will see a separate account on your statements or on the online dashboard after you transfer your money to the CD.

NB
CDs can be held in almost any type of account, including IRAs, mutual accounts, trusts, and savings accounts.

Just be sure to keep your CDs insured through the Federal Deposit Insurance Company (FDIC) or the National Credit Union Administration. Don’t be afraid to ask your bank for a better rate, especially if you’re doing significant business with that bank or credit union.

Types of CDs
Liquid or penalty free CDs
Liquid CDs allow you to withdraw your money early without paying a penalty. That flexibility allows you to move your money into a lucrative CD if the opportunity arises, but it comes at a cost.

Liquid CDs can pay lower interest rates than locked CDs. This makes sense from a banking perspective. They assume the risk of high interest rates. However, it may be worth taking a smaller amount for a short period of time if you can change more money later, and if you are sure that the rate will rise quickly.

Make sure you understand the limitations if you’re considering investing in a liquid CD. Sometimes you only have when you can spend money and how much you can bring in at a time. You may also need to put more money up front than with other types of CDs.

Support CD
Extended CDs offer the same benefit as liquid CDs. Don’t get stuck with a lower yield if interest rates go up after you buy one. You can keep your existing CD account and switch to the new, higher rate offered by your bank.

NB
You may have to notify your bank in advance that you want to exercise your upgrade option. The bank assumes that you will be stuck with the current rate if you do nothing. Also, you don’t get unlimited upgrades.

Like Liquid CDs, Enhanced CDs usually start paying lower interest rates than standard CDs. You may be able to cope if prices rise sharply, but if prices remain stagnant or decline, you’d be better off with a trendy CD.

DC increases
This comes with regularly adjusted interest rate increases so that you are not stuck with the rate in effect at the time you purchase your CD. The increase may come in six to seven months.

Circulating CDs
Brokerage CDs are sold in brokerage accounts. Instead of opening a bank account and using your selection of CDs, you can buy circulation CDs from several exporters and store them all in one place. This gives you some options, but spinning CDs carry additional risks.

Make sure any issuer you are considering is FDIC insured. No wonder unsecured CDs cost more. Getting out of a front-rolling CD can also be difficult.

Larger CDs
As the name suggests, mega CDs have a strictly required minimum balance, usually over $100,000.They are a safe place to park a lot of money because up to $250,000 is FDIC insured and you will get a much higher interest rate.

The days are over
The CDs will expire at the end of their terms and you will have to decide what to do next.