If you’re looking for safe, dependable ways to grow your money, certificates of deposit (CDs) may be high up on your list. In fact, these savings accounts actually might be the closest thing to “free money” when it comes to investing.
But do you really know how a CD works? We’ve compiled five facts you may not know about CD accounts… and how they affect your money.
First off, let’s take a little refresher on the ins-and-outs of CDs.
What Are CDs?
CDs are a savings vehicles issued by banks and credit unions. In other parts of the world, they’re commonly referred to as “time deposits.” This name makes it quite clear how these types of accounts work. You deposit an amount of money into a CD for a fixed amount of time, during which it accrues a guaranteed rate of interest.
CDs issued by banks are insured by the Federal Deposit Insurance Corp. (FDIC), and those issued by credit unions are insured by the National Credit Union Administration (NCUA). That means, in both cases, your money is protected up to $250,000.
In return for a guaranteed, fixed interest rate, you allow the financial institution to hold your money for a set amount of time. This can be any duration from three months to several years. After the fixed period of time, the CD is said to have “matured.” If you make an early withdrawal, you’ll have to pay a penalty.
Typically, the bigger the required minimum deposit and the longer the time to maturity, the higher the interest rate. Some banks, such as CIT Bank and USAA Federal Savings Bank offer Jumbo CDs with a boosted APY in exchange for a larger-than-usual deposit.
There are several strategies for maximizing CD investing, including staggering CDs with different maturity dates. This strategy is commonly referred to as a “CD ladder.”
5 Things You May Not Know About CDs
Despite the popularity of CDs, most people don’t fully understand how they work. Here are five nitty-gritty details you probably don’t know about these types of accounts.
1. Most CDs will automatically renew at the end of maturity
What happens when your CD reaches maturity and you don’t withdraw the money? It’s highly unlikely that your bank will automatically cut and mail you a check. Instead, in most cases, your deposit will be automatically rolled into a new CD.
This isn’t a bad thing, especially if interest rates are improving. But if your new interest rate is less than stellar – or if you need that money for something – you’ll be up a creek. If you withdraw the money once it’s been reinvested in another CD, you’ll have to face some potentially stiff fines.
So mark your calendar with your CD’s maturity date!
2. Not all CDs have early withdrawal penalties
On the other hand, some banks offer no-penalty CDs that allow you to withdraw money at anytime during the life of the term (after a six-day grace period) without paying a fee. You even get to keep any interest you may have accrued. Of course, you’ll earn a much lower interest rate with this type of CD.
Ally Bank and CIT Bank are two institutions that offer these no-penalty CDs.
Other banks may offer an 8- to 15-day grace period for a no-penalty withdrawal after initial deposit for new CDs.
Bottom line: Be sure to read the fine print.
3. You can open multiple CDs at one time
This is what makes CD ladders possible. Financial institutions allow you to open numerous CD accounts at one time without restriction to terms or deposit amounts. However, be sure you understand the bank’s specific terms regarding accounts before purchasing its CDs.
4. Minimum deposits, lengths of terms and rates will vary by bank and type of CD
Minimum deposits can range from $0 to $1,000,000, with term lengths from three months to 10 years.
Some banks that offer a $0 minimum deposit will close your account if you don’t make a deposit within 30 days of opening the account.
And as always, a substantial deposit and longer term will usually earn the highest interest rate.
Banks will always compete for your money and try to offer the highest interest rates. This is another reason why the CD ladder is worth looking into. And the accounts in your ladder don’t have to be all in one bank. When a CD matures, shop around for the best interest rate.
5. There can be hidden fees
With financial institutions competing against each other, fees are becoming a thing of the past, but don’t assume the bank or credit union you choose doesn’t have any fees.
Be sure there are no hidden fees associated with opening and managing the account. And fully understand what the early withdrawal penalties are, just in case something happens and you need that money early. No one knows the future; you may as well know what it might cost.
What experiences do you have with CDs? Share with us and others in the Comments Section below.