A closer look at certificates of deposit
May 18, 2022 |5 min read
Ever sat down to do a 1,000-piece puzzle and after hours (or days) of working on it, you can finally put in the last piece? That finishing touch can feel rewarding. Yet, chances are, getting there didn’t come without a little work. You had to sort, search, try and test before it all came together.
In the world of CDs, which stand for certificates of deposit, it can also take some time to find the right fit for you. A CD is a kind of bank account that lets you save your money for a certain amount of time. After that amount of time ends, you receive your money back, along with extra cash your money has earnedin interest.1If you do your research and choose a CD that works for you, you could create a financial masterpiece.
What are CD terms?
CD terms refer to the length of time your money stays in a CD. Typically, when the term ends, you can access the money again without penalty.1
Just like a puzzle might have different-sized pieces, CDs have different terms. Some terms might be shorter, such as only a few months. Others could be longer, like 2 years, 5 years or even longer.
CDs also typically come with a fixed savings interest rate, which is money you earn from the bank in exchange for leaving your money in the account. This rate can show you how much your money will earn.
How long do you have to leave money in a CD?
When you open a CD, you can decide how long you want to leave your money in it based on the terms your bank offers. It might be a good idea to choose a term that lines up with your savings goals.
If you need to take out your money before the term is over, you might have to pay a fee called a penalty.1
Your savings goals might help you decide the best timing for CD terms. For example, a short-term CD, ranging from a few months to a year, might be useful for saving for an upcoming wedding or vacation. Midrange CDs that are between a year and three years, could be a good option if you want to save for something like having a baby. And long-term CDs that stretch beyond that could be good for extended savings goals.
What is the average savings interest rate on a CD?
Interest rates on CDs vary too. If you put your money in a short-term CD, you might receive a lower interest rate than if you put away your money for a longer time.2 Generally speaking, the longer you leave your money in, the higher the rate might be.
Types of CDs
While the basic design of a CD involves a set savings interest rate and time, there’s a wide selection of CDs available. Different CDs can be used for different purposes. Here are a few examples:
- Traditional CD: If you choose a traditional CD, you will likely have a CD with a fixed savings interest rate and a term.2
- Bump-up CD: This type of CD lets you increase the savings interest rate if it’s available. Suppose you start out with a CD at a 1% rate. After you open the CD, the financial institution raises their rate to 1.5%. You can ask to have this rate applied to your CD. The benefit of a bump-up CD is that if rates increase, you can have the savings interest rate on your CD go up, too. A potential drawback can occur with the starting rate—the first rate you have for a bump-up CD may be lower than the rate offered for other CDs that don’t allow the rate to be bumped up.3
- IRA CD: An IRA, or individual retirement account, is an account that can be used to save for retirement. Once you put money into your IRA, you can choose to put money from the IRA into a CD, which is referred to as an IRA CD.2
- Jumbo CD: A jumbo CD is bigger than some other CDs. This type of CD usually has a high minimum balance, the lowest amount you can put into the CD. A jumbo CD might ask that you put in at least $100,000. In return, this type of CD might offer a higher interest rate.4
- Liquidity CD: This type of CD allows you to take out your cash before the term is up. In many cases, you won’t have to pay a fee for doing so. Say you put $5,000 in a 3-year liquidity CD. If you need the $1,000 after a year, you may be able to take that amount out of it without a penalty. Some liquidity CDs have limits on how much you can take out without a penalty. They also might offer lower rates than other CDs that don’t offer the option of accessing your cash early.5
Similar to a 1,000-piece puzzle, there are a lot of moving pieces when it comes to CDs and their terms. Before deciding what term to get, take a look at all of the options available and think through your savings goals. This can help you find the right CD term fit for you.
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