Certificates Of Deposit

A certificate of deposit or CD is, in the United States, a time deposit, a familiar financial product, commonly offered to consumers by banks, thrift institutions, and credit unions.

Such CDs are similar to savings accounts in being insured—by the FDIC for banks or by the NCUA for credit unions—and thus virtually risk-free; they are "money in the bank." They are different from savings accounts in that the CD has a specific, fixed term—often three months, six months, or one to five years—and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest.

source: Wikipedia

 How CDs Work

The consumer who opens a CD may receive a passbook or paper certificate, but as of 2004 it is common for CD to consist simply of a book entry and an item shown in the consumer's periodic bank statements; that is, there is usually no "certificate" as such.

At most institutions, the CD purchaser can arrange to have the interest periodically mailed as a check or transferred into a checking or savings account. This reduces total yield because there is no compounding. Some institutions allow the customer to select this option only at the time the CD is opened.

Commonly, institutions mail a notice to the CD holder shortly before the CD matures requesting directions. The notice usually offers the choice of withdrawing the principal and accumulated interest or "rolling it over" (depositing it into a new CD). Generally, a "window" is allowed after maturity where the CD holder can cash in the CD without penalty. In the absence of such directions, it is common for the institution to "roll over" the CD automatically, once again tying up the money for a period of time (though the CD holder can specify at the time the CD is opened to not "roll over" the CD).

CDs typically require a minimum deposit of at least $1,000 US, and may offer higher rates for larger deposits. The best rates are offered on "Jumbo CD's" with minimum deposits of $100,000 (though some, recognizing that some investors don't want more in the account than is covered by FDIC insurance, have lowered the minimum deposit to $99,000).

Withdrawals before maturity are usually subject to a substantial penalty. For a five-year CD, this is often the loss of six months' interest. These penalties ensure that it is generally not in a holder's best interest to withdraw the money before maturity—unless they have another investment with significantly higher return or have a serious need for the money.

Rates

In exchange for keeping the money on deposit for the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand. For example, as of 2006 one well-known bank offers 0.75% annual interest on savings accounts from which withdrawals may be made on demand, 2% on a 3-month CD, and 4.5% on a 2-year CD.

Fixed rates are common, but some institutions offer CDs with various forms of variable rates. For example, in mid-2004, with interest rates expected to rise, many banks and credit unions began to offer CDs with a "bump-up" feature. These allow for a single readjustment of the interest rate, at a time of the consumer's choosing, during the term of the CD.

A few general rules of thumb for interest rates are:

The larger the principal, the higher the interest rate.
The longer the term, the higher the interest rate.
The smaller the bank, the higher the interest rate.

CD Refinance

In the U.S. insured CDs are required by Truth in Savings Regulation DD to state at the time of account opening the penalty for early withdrawal. These penalties can not be revised by the depository prior to maturity. The penalty for early withdrawal is the deterrent to allowing depositors to take advantage of subsequent enhanced investment opportunities during the term of the CD. In rising interest rate environments the penalty may be insufficient to discourage depositors from redeeming their deposit and reinvesting the proceeds after paying the applicable early withdrawal penalty. The added interest from the new higher yielding CD may more than offset the cost of the early withdrawal penalty.

Terms & Conditions

By law, the Federally-required "Truth in Savings" booklet, or other disclosure document that gives the terms of the CD, must be made available before the purchase. The purchaser should read the terms very carefully before buying a CD. Employees of the institution are generally not familiar with this information.

It is vital that you study the Truth in Savings booklet. A few institutions have it online; all are required to make it available to you before you deposit money. Go into the branch and get one or ask them to mail you a copy. Take it home to study and mark it up. While the booklet is at first overwhelming due to the length and tiny type, the portion of the booklet covering the terms specific to CDs is only one page.

Do not rely on verbal answers to these vital questions; only the booklet carries any legal weight.

source: Wikipedia