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How Does a Certificate of Deposit Work?

How Does a Certificate of Deposit Work? PhotoPreparing for the future is vital that’s why learning how to save money is a must. Banks help by offering several kinds of savings account to suit your needs – one is a certificate of deposit.

What’s with this type of bank account and how different is it from the others?

What is a certificate of deposit?

A Certificate of Deposit (CD) is also known as time deposit account wherein money deposited yields more the longer it is untouched. The institution and the client agree on how long the deposit should be held and the interest rates that will be applied to it. It’s usually offered by banks and credit unions in the United States.

Difference from other accounts

It’s similar to a regular savings account in the sense that it’s under the insurance of the FDIC and NCUA.

One difference between these two is that you can’t just withdraw money from a CD as easy as with a regular savings account. You’ll only be free to touch your savings just after maturity which could be anywhere between a period of 3 months, one year to even a lengthy three years. The interest rates also vary with CDs having more favorable rates.

Why would banks give you more favorable interest rates in the first place? By handling them your money for a period of time, more funds will be available for them to move around wherever it’s profitable. A CD is less liquid compared to a regular savings account justifying the higher interest rates.

Advantages and disadvantages

The obvious advantage of this is the significantly higher interest rates that can be accumulated through time. It’s like sowing a seed and reaping the fruits after a year without doing anything at all. Many are attracted to get one since it’s a risk-free investment.

Impulsive spenders would also benefit from this type of account. They’ll be able to keep their money safe from the danger of suddenly spending it on unnecessary things.

One drawback though is that the bank should be notified before any withdrawal is done. Withdrawing an amount before the deposit reaches maturity also has some penalties. There can be additional charges for premature dealings or for breaching the contract agreed upon.

Interest rates

Banks usually offer a fixed interest rate over a period of time. However, more and more banks offer a great deal of CD variations.

There are banks that offer even higher interest rates but with risks of not being insured by either the FDIC or NCUA. In addition, many banks also offer CDs with variable interest rates based on the performance of a specified market index.

Considering a Ladder

Laddering” is a technique to mitigate the drawbacks of CDs. It’s a way to protect money from market fluxes and also makes it more flexible for withdrawal.

Basically, you divide the money you deposit in varying maturity dates. For example you have $18,000 you want to put into a CD. Instead of placing the whole chunk in one account, you divide it into three accounts: $6,000 in a one-year CD, another $6,000 in a two-year, and the last $6,000 in a three-year account. When each account reaches its maturity, you can either withdraw and use it or invest it in another CD, depending on the market status.

Getting a CD

You can apply for a CD in almost any bank you want. You just need to fill up some form and submit the requirements of the bank.

Interest rates and maturity dates are connected so weigh its pros and cons on your savings. There are also some bank promos offering little to no penalty for early withdrawals on your CDs in lieu of additional provisions.

There are advantages and possible disadvantages so choose one that will suit your spending style.

  • Betty Dartouzos

    I always got savings bonds for my granddtr since she was born she is now 12 years old and my bank told me months ago that they do not handle them anymore where can I get savings bonds now???