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What is a CD?

Hattie Burgher  |  September 7, 2018

You may have heard the term "CD" thrown around when shopping for a place to store your money, but what is it, really?

You have some extra cash in your savings account not earning much interest, and you know you’re not going to need to use it for at least a few months — and possibly a few years. Great! But where do you put it where you’ll earn more interest than you’d get in your local savings account?

Enter the certificate of deposit, or CD. You may have heard the term “CD” thrown around when shopping for a place to store your money, but what is it, really?

What Is a CD?

A CD is a “timed deposit account,” essentially, a savings vehicle for your money for a fixed amount of time. It has a fixed interest rate and a fixed withdrawal date — usually months or years from time you make the deposit. Typically, the longer you keep your money in the bank, the more interest you earn. It’s up to you to decide if the difference in interest rates between, say a three-month CD and a six-month CD make it worth it to put your money away for a longer stretch.

CDs have some benefits over traditional savings vehicles: They often offer higher interest rates (in exchange for you committing to leaving your money in place for the agreed upon period). And, like savings and money market accounts, they come with FDIC protection of up to $250,000 per account, per account holder.

The drawback to a CD over, say, a money market account or savings account is liquidity. If you elect to take your money out before the withdrawal date — sometimes called “breaking” a CD — you’ll face early withdrawal fees.

Types of CDs

There are a few types of CDs you should know about before you wade in.

Traditional CD: You deposit a fixed amount of money for a fixed term with a fixed interest rate. You can either take your money out at the end of your term or roll it over for another term. Most financial institutions won’t let you put more money into your CD before the term is up, and you’ll get penalized (you could lose interest and principal) if you withdraw early.
Bump-up CD: This type of CD offers the opportunity to bump up the return on your current certificate if interest rates rise — without waiting to roll over into a new one. A few things to know: Banks only typically let you bump up once per term. And the price for this flexibility may be a lower interest rate than you could get on a traditional CD. Run the numbers on your time horizon to be sure it’s worth it.
Liquid CD: This allows you to withdraw money penalty-free. Again, the interest rate is usually lower than a traditional CD’s, so you’ll have to decide if the increased liquidity is worth the lower return.
Zero-coupon CD: Traditional CDs pay interest throughout their term. With these, you don’t receive any interest payments until your term is up. Be careful: Although you can buy these CDs at big fat discounts (you may be able to purchase a $100,000, 10-year CD for $80,000) you have to pay annual taxes on your gains long before you receive them.
Callable CD: The bank that issues your CD can “call” it away — forcing you to redeem it — before your term is up. If interest rates have dropped, you could be stuck looking for another CD in which to put it at less attractive rates. Note: Some zero-coupon CDs are callable.
Brokered CD: A brokered CD is one that is sold through a brokerage firm, so you’ll need a brokerage account to get one. Interest rates can be higher than CDs through banks, but be careful, brokered CDs are traded like bonds. The only way you can guarantee getting your full principal and interest is to keep your CD until the term is up. Also important: Brokered CDs may not offer FDIC protection.
High-yield CD: This kind of CD offers a higher interest rate than a traditional CD — but the catch is you’ll have to make a larger deposit. This is a good option if you want to save for long-term, bigger goals like college or a down payment on a house.

Should I Open a CD?

If you’re a savvy saver and can afford to sock away at least $500 to $1,000 (usually the minimum deposit requirement) for a few years, a CD could be a viable option for you. When trying to decide whether you can afford to lock up your money for an extended period of time, do a quick check-in with yourself — do you have enough money readily accessible in case of an emergency? If not, then I’d hold off on opening a CD, because if you needed your money in a pinch and withdrew it before your term was up, you’ll likely have to pay a penalty — and that’s never fun! Instead, put your emergency savings in an even more liquid account.

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