What Is a Certificate of Deposit?

What Is a Certificate of Deposit?

Kim Pinnelli

by Kim Pinnelli
Senior Contributing Writer

February 12, 2020
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What Is a Certificate of Deposit?

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Investing your money doesn’t mean you have to buy stocks.

You have numerous options including placing your funds in a Certificate of Deposit. While you won’t get the same level of return you would in the stock market (when it does well), it is a safe and lucrative way to make your money grow faster than a standard savings account allows.

Just how does a certificate of deposit work?

How Does a Certificate of Deposit Work?

CDs work in a similar fashion as savings accounts. You deposit your money and the bank pays you to leave it there. The difference, however, is the length of time you must leave the funds.

With a savings account, you can withdraw your funds at any time (a maximum of 6 times per month) with no penalties. CDs, however, only allow withdrawals upon the maturity of the CD.

If you withdraw your funds early, you’ll pay a penalty, which is typically an average of 6 months of interest. The penalty varies by bank, though. Some banks offer tiered programs that decrease the penalty the closer you get to the CD’s maturity date.

The terms also vary by bank. You may find short one-month CDs, but most commonly, banks offer 6-month, 1-year, 2-year, 5-year, and 10-year CDs. The longer the term you choose, the higher the interest a bank pays. That’s because they get use of your money for a longer period in exchange for the interest they pay you (much like you’d pay interest on a loan from the bank).

Upon maturity, you can withdraw the funds or roll them over into another CD – the choice is yours. As long as you don’t withdraw the funds before maturity, you’ll pay no fees.

Types of CDs

The most common CD type is the traditional CD that we spoke about above, but some banks also offer the following:

  • Liquid CDs – You get the option to withdraw a portion of your funds early without penalty, should you need them.
  • Bump-Up CDs – If interest rates rise during your CD term, you may have the option to increase your rate one time
  • Brokered CD – Brokers pool the funds of multiple investors together to help you earn higher interest rates. It also gives you more liquidity. If you need to withdraw your funds, the broker may be able to sell your portion to another investor, allowing you to avoid the penalties.
  • Jumbo CD – If you have more than $100,000 to invest, you may buy a jumbo CD which typically pays much higher interest rates.

Are CDs Safe?

Like savings accounts, as long as you invest your money in an FDIC-insured bank, you are insured up to $250,000. This means if the bank goes under, you’ll still get your money back from the CD. It may take a little while, but the guarantee is there.

If you have money you want to keep somewhat liquid and safe, a CD can be a great option. You’ll earn interest, but have access to your funds in a period that you designate.