Certificates of Deposit: An Explanation
When you hear about someone investing in CDs, do you imagine them going to the music store and stocking up? That’s probably not the case. In financial terms, “CD” stands for certificate of deposit, a popular instrument for earning interest on one’s money in the short term.
Certificates of deposit are issued by banks, credit unions and other financial institutions. Their purpose is to raise money for lending purposes. For this reason, CD holders must commit to leaving their money on deposit for a certain amount of time. It is usually possible to make an early withdrawal, but doing so will result in a penalty.
The maturity date of a CD is simply the length of time that the depositor agrees to leave his money in the bank. This usually ranges from three months to five years. The longer the maturity on a CD, the higher the interest rate you receive will usually be.
Banks may also offer different interest rates for CDs with different minimum deposits. The larger the deposit, the higher the interest may be. Some banks offer CDs with a minimum deposit of as little as $1,000, while others require a higher deposit. Jumbo CDs with minimum deposits of $100,000 are also available, but it’s important to remember that the FDIC does not normally insure investments above that amount.
For those who want to know exactly how much interest they will earn, a fixed-rate CD is a good choice. The interest rate is agreed upon when the CD is purchased, and even if interest rates drop while your money is on deposit, your interest will remain the same. This can, however, be a disadvantage if interest rates rise before your CD matures.
Not all CDs feature fixed interest rates. Some have variable rates that may change with current interest rates or adjust according to a predetermined schedule. Some banks also issue CDs that may be “bumped up.” This means that the CD holder may request that the interest rate be updated to current rates once during the CDs term.
Some CDs are callable, which means that the issuer can terminate them after a certain period of time. If this happens, your deposit is returned to you along with the interest that has been accrued up to that point. A bank might decide to call a CD if interest rates have dropped to avoid paying the higher interest rate. But the depositor must still pay a penalty if he withdraws money prior to the maturity date.
Certificates of deposit are not right for everyone. If you need easy access to your money, a money market account might better suit your needs. But if you are looking to earn interest on money that you do not plan to use in the near future, and you want the reassurance of FDIC coverage, a CD might be for you.