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How to Choose a Certificate of Deposit
Certificates of deposit (CDs) are accounts with guaranteed returns, so they're a perfect place to invest money that: A) you don't need immediately, and B) you don't want to risk in other types of investment.
As a financial planning tool, CDs can meet short- and long-term savings goals, such as a wedding, a vacation or a down payment on house or car. CDs come in many different variations, and this article will show you how to choose the ones that best suit your goals. So, let's review some CD basics, including their differences from other types of savings accounts, types of CDs, term lengths and how they can help provide financial security.
What is a certificate of deposit (CD)?
A certificate of deposit, or CD, is a type of savings account offered by banks and other financial institutions. One distinguishing feature of the CD is that you agree to keep your money in the CD for a specified length of time (the CD term) without taking a withdrawal. Unlike a personal savings account , which you can access at most any time, withdrawing money before the CD term is up means paying early withdrawal penalties.
Opening a CD is just a matter of meeting the deposit required. Minimum deposits vary based on term length and financial institution, but a minimum deposit requirement is common when opening a CD.
Longer terms typically yield higher interest rates, but even a short-term CD may give you a better Annual Percentage Yield (APY) than a regular savings account.
Like other accounts at insured banks, CDs are protected by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor per institution per account category.
Different types of CDs
Banks have developed different types of CDs to meet the needs of their depositors, whether they have $500 to deposit or $100,000. Here are some you can expect to find when seeking out a CD that works for you.
Traditional CDs
With a traditional CD, you make a one-time deposit that meets the bank’s minimum deposit requirement. The money stays with your bank for a specific term—from three months to five years, for example—and earns a fixed interest rate. At the end of the term, you can cash out the CD or roll the money over to a new CD.
If the bank permits any withdrawal before the maturity date, early withdrawal penalties may be applied.
Jumbo CDs
Jumbo CDs work the same way as traditional CDs, requiring you to commit your money for a fixed term to earn a guaranteed interest rate. However, a jumbo CD requires a much higher minimum deposit, often $100,000.
Interest rates on jumbo CDs tend to be higher than the rates for those requiring smaller minimum deposits. This type of CD typically attracts high-net-worth investors, institutional investors, and commercial banking customers and institutional investors than individuals.
No-penalty CDs
Some banks offer a CD that permits one penalty-free withdrawal per term or per year for long-term CDs. The minimum deposit is typically lower—some as low as $0—and the APY can vary.
Bump-up or step-up CDs
These types of CDs increase the interest rate the longer the money is held. A step-up CD tends to have a fixed schedule, such as yearly, for each rate change.
With a bump-up CD, you can request a rate boost if the bank is currently offering new CDs at a higher rate than the one you opened, for the same term length.
High-yield CDs
If a bank is offering a CD interest rate significantly higher than the national average, it can probably be characterized as a high-yield CD. These are mainly offered at online banks, which don't have the expense of bricks-and-mortar locations. The downside is that all of your transactions will be digital with little to no access to a branch.
Common CD terms
With a CD, timing is everything if you're going to maximize your return. CD terms, or the time needed for the CD to reach maturity, can be measured in months or years. Longer CD terms are typically one year, 18 months, two years, three years and five years. At some banks, they go up to 10 years.
Because of early withdrawal penalties, it is important to align your CD terms with when you expect to need the money. You can hedge your bet by "laddering" CDs. In other words, you purchase several CDs with staggered maturities to take advantage of higher interest rates while preserving your ability to access funds on a regular basis.
What to consider before opening a CD
Before opening a CD, be sure to request the complete terms and conditions being offered by the bank. Here are some of the things to think about when choosing:
- Annual Percentage Yield (APY). The APY represents the actual growth of the account over one year thanks to compound interest. APY is expressed as a percentage
- CD terms. The length of time it takes a CD to mature is a key consideration. You don't want to commit to a 12-month CD if you'll need the money in six months
- Minimum deposit required. The key question here is, "How much money can you reasonably afford to lock up in a CD and feel no need for it until the CD matures?" Some CDs allow you to add money during the term
- Early withdrawal penalties. If you do need to cash it in early, how much of a penalty will you incur? On a five-year CD, you could lose the equivalent of a whole year of interest. If this concerns you, consider a penalty-free CD
CDs from TD Bank
Flexible terms with predictable return
Increasing interest rates plus one penalty free withdrawal1
Flexibility, guaranteed rates and one free withdrawal