What is a Certificate of Deposit, and what is the difference between it and a simple savings account?
These accounts are more commonly known as “CD” accounts. They are insured and virtually risk-free and are similar to a savings account. But, they differ from a savings account in that they are assigned a specific ‘term.’ These terms are often three month, six month or one to five years. There is also an rate of interest assigned to the account. The idea being that the one who deposits the money into a CD account leaves it there until it matures or reaches the end of the term and therefore earns the accrued interest.
The bank offers a higher interest rate in return for being able to keep the money for a specific time period. It gives them more flexibility in their own investing to help them make more money as well. But, they share in that increase by the higher rates of interest. Fixed rates of interest are the most common, but there are some institutions that offer a variable rate. The best rates can be found on deposits of $95,000.00.
You might find these features being offered: a higher interest rate on a higher balance. A longer term offers a higher interest rate. Smaller financial institutions offer higher rates than do the larger ones. Personal CD accounts offer better rates that do business accounts. Higher interest rates can be found at banks and credit unions that are not insured by the FDIC or the NCUA.
Payout of Interest. The CD owner can choose to have the interest mailed in the form of a check or deposited to a checking or savings account. Sometimes you are required to make this choice at the time that the account is opened.
Close Out Penalty. If you close the CD or make withdrawals before the maturity date, there are substantial penalties. Also, you are notified shortly before the CD matures and are given a window in which you can take the desired action of pulling out the money and interest that it earned, or leaving it to roll over into another CD account.
Callable CDs. Some banks may state in their terms that they can close the CD account before the term ends.
CDs are a great way to realize a higher interest rate. But the caveat here is to make sure that you only deposit money that you are certain will not be needed immediately or you will pay dearly for early withdrawal. While not every life situation can be anticipated, it does make sense to only open this type of account after you have already fully funded standard savings and money market accounts that give you a buffer.
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