Posted on June - 02 - 2010
What is a Certificate of Deposit (CD)?
In your daily travels, perhaps you have seen signs in bank windows advertising, “12 Month CDs 2.8%!” To those without a background in banking or strangers to saving money, it might look and sound like gibberish. Let’s dispel the confusion and go over what a certificate of deposit is and how it works.
What is a CD?
A CD is a savings tool. Simply put, it is a way of stashing away money for months at a time to earn more interest than you would in a traditional savings account. You’re basically giving up your right to access the money for the length of the account to get a high interest rate on money you wouldn’t need to touch right away.
How do certificates of deposit work?
CDs have two main components: length and interest rate. Generally speaking, the longer the length of account, the more interest you can expect to receive as compensation. Think of it like you lending the bank money for X amount of months and getting paid Y% interest for it.
Lengths for certificates of deposit generally start at 3 months and can go up to roughly two years depending on the financial institution. In my personal experience, the most common lengths I have seen are: 3, 6, 9, 12, and 18 months. The deal is you deposit your money into this account for the length you choose and cannot withdraw from it without a penalty until you reach the “maturity date” (the end of the account length.) Withdrawal penalties vary by bank, but there never is a penalty for depositing more money into the account.
Interest rates are determined solely by the bank. They can vary quite a bit, sometimes even changing from day to day. Therefore, it’s important that you check on these types of accounts regularly to find the best interest rate. For higher interest rates than you would typically find in traditional banks, check out online savings accounts and online CDs.
Is there a catch?
Nope. The only thing to keep in mind for these types of accounts is that you should be putting money into them that you are not looking to spend right away. Most CDs do have penalties for withdrawing fund earlier than the “maturity date,” so it is important to gauge how long you need to save the money accurately.
College savings are particularly useful as a reason to open a certificate of deposit, especially if you are a parent. The ability to lock in a good interest rate when your child is young and continually add more money to the account over their childhood will amass a small fortune by the time they are ready to go to school.
Have questions about certificates of deposit (CDs)? Ask them in our student credit forum.
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