How Does a Certificate of Deposit Work (CDs)?
Last Updated: March 14, 2024
Have you been looking for a low-risk way to save money that earns more than a traditional savings account? Certificate of Deposit (CD) accounts are a popular choice for savers looking to earn interest while keeping their money safe.
But what are they, how do CDs work, and are they safe? Moreover, is there more than one type of CD? And how much can you earn in interest? Here’s everything you need to know about how CDs work.
What is a Certificate of Deposit?
A CD is a savings product offered by banks and credit unions. It often provides higher interest rates than regular savings accounts. With a CD, you keep a specific amount of money in the account for a predetermined period. The predetermined period that money stays in a CD is called the term.
CDs are available in various terms, ranging from a few months to several years. The longer the term of the CD, the more you will typically receive at the end. However, you may not be able to access your money during the term of the CD without incurring penalties.
Because of the early withdrawal penalties, CDs aren’t the best fit for items like emergency funds. And, since their terms are short, they are not ideal for long-term goals like retirement. However, CDs can be great for short-term savings needs like events, vacations, or down payments.
CDs can be a good option if you want a low-risk, predictable account to grow your savings over a set period. However, it's vital to consider the terms and conditions of the CD carefully. Look at the annual percentage yield (APY), term length, and potential penalties before you choose
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How Do CDs Work, Rates/Interest?
When you open a CD, you deposit a lump sum of money into the account. The interest rate on the CD is typically fixed for the entire term.
The earnings is called interest. Interest is usually paid or credited into the account monthly, quarterly, semi-annually, or annually. When you get paid is based on your CD's conditions.
When the CD matures, you get your initial deposit plus all the interest you've earned.
Some key benefits of CDs are that:
- CDs offer a fixed rate for the entire term. This provides stability and predictability in your returns.
- Compared to regular savings accounts, CDs generally offer higher interest rates. This allows you to grow your savings more efficiently.
- CDs come with various term lengths. This allows you to choose an account that aligns with your financial goals and risk tolerance.
While this is generally a safe arrangement, withdrawing a CD before maturity can result in early withdrawal penalties. So, it's important to commit to the term before you deposit money into a CD account.
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What's the Difference Between a CD Interest Rate and APY?
A CD interest rate and APY sound similar, but they are not the same.
Here’s how they work:
- A CD interest rate tells you the base rate the bank pays on your deposit. It shows the simple rate before any compounding.
- APY, or annual percentage yield, shows how much you earn in a full year after compounding is included. Compounding means the interest you earn also earns more interest over time.
You can think of the CD interest rate is the starting point. APY is the final number that shows your real earnings. When a bank compounds interest more often, the APY goes up, even if the base rate stays the same. That is why APY is usually a little higher.
When you compare CDs from different banks, APY may give you the clearest picture. It can help you see which CD pays more over a full year. The CD interest rate can still help you understand the basic return. But APY tells you what you actually take home.
Always check both numbers, so you know exactly how your money grows.
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Are CDs Safe?
Because they are FDIC-insured, CDs are considered low-risk. This means that even if the bank or credit union fails, your money will be protected.
CDs are backed by the Federal Deposit Insurance Corporation (FDIC) for banks or the National Credit Union Administration (NCUA) for credit unions. With CDs, your deposits and credited interest are protected up to the insured limit.
The FDIC insures accounts up to $250,000 per account ownership category[1]. Likewise, the NCUA insures up to $250,000 per account holder[2].
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How to Open a CD
To open a certificate of deposit (CD) at Centier Bank, you start by picking a CD term you want. Terms can be short, like 3 or 6 months, or longer, up to 60 months. You also need at least $1,000 to start most CD accounts.
Next, gather some basic personal info.
You’ll need:
You can open the CD in a couple ways:
- You can go into a Centier branch and talk to a banker.
- You can start the process online through the Centier website.
A bank representative will ask you to fill out the application and make your deposit.
When you fund the CD, your money is locked in for the term you chose. You earn interest at a fixed rate for that period. At the end of the term, called maturity, you can take out the money or roll it into a new CD. Centier will tell you when your CD is about to mature.
Different Types of CDs & How They Work
When saving in a CD, understand that not all CDs are created equal. Banks and credit unions offer various types of CDs, each with its own set of features and benefits. Let’s get to know the different types of CDs available.
We’ll explore a range of options from traditional term CDs to climbing rate and birthday CDs.
When you understand these variations, you can choose the type that best aligns with your financial goals. Let's dive into the details of each type to see how CDs work and which one might be right for you.
Check it out: Why Would Someone Use a Certificate of Deposit?
Term CDs
Term CDs are the most straightforward type of certificate of deposit, where you deposit funds for a fixed period, usually ranging from three months to five years. During this time, your money earns interest at a predetermined rate. You cannot withdraw your funds without penalty until the CD matures.
Term CDs offer predictable returns and are suitable for those looking to save for short to medium-term goals.
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Option CDs
Option CDs provide more flexibility than traditional CDs by allowing you to adjust the earning rate or withdraw funds penalty-free before the CD matures. This option gives you greater control over your savings.
Option CDs can be beneficial if you expect changes in rates or may need access to your funds.
Climbing Rate CDs
Climbing Rate CDs or Interval CDs offer a gradually increasing interest rate over the CD term. This allows you to benefit from rising rates. These CDs typically start with a lower interest rate that increases at regular intervals, providing the potential for higher returns over time.
Climbing Rate CDs are suitable if you want long-term growth and protection against inflation.
Guaranteed Growth CDs
Guaranteed Growth CDs ensure a fixed rate of return over the CD term. This offers an added layer of stability and predictability. With this type of CD, you know exactly how much interest you will earn throughout the term.
Guaranteed Growth CDs are a great option for those who prioritize safety over returns.
How Do I Choose a CD?
Start by deciding how long you can leave your money in the account. CD terms range from a few months to several years. A shorter term gives you quicker access to your money, while a longer term often pays a higher rate.
Then look at the APY, which shows how much you will actually earn over a year. Even a small difference in APY can change your total earnings.
You also want to think about your goals. If you know you will need the money soon, a short-term CD may fit best. If you want steady growth and do not plan to touch the money, a long-term CD might be better.
Make sure you check the minimum deposit, early withdrawal penalties, and how interest is paid.
Start Saving Money for Your Future with Certificates of deposit at Centier Bank
CDs are powerful tools for secure savings and financial growth. By understanding how CDs work and exploring the diverse options, you can harness their potential to achieve your financial goals.
Whether you want a traditional term CD or something more outside the box, being informed will help you make the best decision. Your journey to financial success begins here.
To unlock a world of possibilities, explore Centier Bank's CD options and start saving today. Take control of your financial future and start saving with confidence.
Frequently Asked Questions
How do interest rates affect CDs?
Interest rates decide how much your CD earns. When rates go up, new CDs may pay more. When rates go down, new CDs can pay less. Once you open a CD, your rate usually stays the same for the whole term.
Are CDs a good place to keep emergency funds?
CDs can work for emergency savings, especially if you choose short terms. A long-term CD locks up your money, and taking it out early can lead to penalties. Many people keep most of their emergency fund in a regular savings account.
What is CD laddering and how does it work?
CD laddering means you open several CDs with different end dates. As each CD matures, you can use the money or roll it into a new CD. This gives you regular access to part of your funds and helps you earn steady interest without locking everything up at once.
Can CDs be part of a retirement strategy?
Yes, CDs can support retirement plans. They offer steady, low-risk growth. This can help balance higher-risk investments. CDs alone won’t build a full retirement, but they can add safety and predictability to your mix.
What is the penalty for early CD withdrawal?
If you take money out before the CD term ends, the bank usually charges a penalty. This is often a set number of months of interest. The exact amount depends on the CD term and the bank’s rules.
Sources:
[1] https://www.fdic.gov/resources/deposit-insurance/brochures/insured-deposits/
[2] https://ncua.gov/newsroom/press-release/2020/deposits-are-safe-federally-insured-credit-unions