What are Certificates of Deposits (CDs) and How Do They Work?
The Basics of a CD
Have you ever overheard your co-workers in the lunch room chatting about how CDs are looking like a solid investment again? No, they were not talking about the new Justin Timberlake CD - although that doesn't sound like a bad investment either - they're talking about Certificates of Deposit. Don't worry if you were out of sync though, you're not alone, and this blog is for you!
What is a Certificate of Deposit (CD) and how does it work?
A Certificate of Deposit (CD) is a savings vehicle that pays a higher interest rate, but you must ‘lock up’ your money into that account for a specified period of time. You'll receive a higher annual percentage yield (APY) on the funds in a CD, because the bank knows that it can use your money for longer-term investments (like Mortgage or Commercial loans). It is possible to get that money out early, but you'll end up paying a penalty.
The time period you keep your money the CD is called the "term". A term of a CD can be as short as a few months or as long as a decade. Generally you will see that the longer the term, the higher the interest rate.
A CD comes with a “maturity date”. The CD “matures” (another way to think of it is as “expires”) at the end of its term, and you'll have to decide what to do when that time comes. The bank will notify you as you near this date, and it will give you several options. You will want to let the bank know before the renewal deadline if you want to do something other than reinvest into a new CD. You can transfer the funds to your checking or savings account, or you can switch to a different CD. If you do nothing, your money will most likely be automatically reinvested into another CD.
How is a CD Different than a Savings Account?
Savings accounts let you deposit and withdraw funds relatively freely. But with a CD, you typically agree to leave your money in the bank for a set amount of time (the term length) during which you can’t access the funds without paying a penalty. Term lengths can be as short as a few months or as long as a decade, but the standard range of options is between twelve months and five years.
Should you open a CD?
If you're sitting on a decent amount of cash in a traditional savings account and you're pretty sure you're not going to need that money for a while, putting it in a CD could be a smart move. It will allow you to earn more interest on that money. Depending on how long you want to tie your money up and the amount of your deposit, you might actually double the amount of interest you earn. However, if the money you've accumulated in savings is your emergency account, or money you will want to use in the coming months, you might want to consider keeping it in that savings account.
Different banks will offer different interest rates for any given CD. If you feel that a CD is the right thing for you – learn more about Bank Five Nine's CD offers here.