A certificate representing a fixed-term, interest-bearing deposit in large denominations, which can be bought and sold. The concept was first introduced by Citibank in New York City in 1961; sterling certificates were introduced in 1968.
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. 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 It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest.
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the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand, although this may not be the case in an inverted yield curve situation. 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.How CDs work
The consumer who opens a CD may receive a passbook or paper certificate, but it now is common for CD to consist simply of a book entry and an item shown in the consumer's periodic bank statements;
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. 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 may be able to specify at the time the CD is opened to not "roll over" the CD).
CDs typically require a minimum deposit, and may offer higher rates for larger deposits. In the US, the best rates are generally offered on "Jumbo CDs" 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 $95,000). For a five-year CD, this is often the loss of six months' interest.
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. 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.
Ladders
While longer investment terms yield higher interest rates, longer terms also may result in a loss of opportunity to lock in higher interest rates in a rising-rate economy. A common mitigation strategy for this opportunity cost is the "CD ladder" strategy. In the ladder strategies, the investor distributes the deposits over a period of several years with the goal of having all one's money deposited at the longest term (and therefore the higher rate), but in a way that part of it matures annually.
For example, an investor beginning a three-year ladder strategy would start by depositing equal amounts of money each into a 3-year CD, 2-year CD, and 1-year CD. From this point on, a CD will reach maturity every year, at which time the investor would re-invest at a 3-year term.
Deposit insurance
In the US, the amount of insurance coverage varies depending on how accounts for an individual or family are structured at the institution.
Terms and conditions
It is vital that you study the terms and conditions for a CD before purchase.
In the US, 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.
Check out the institution offering the CD:
Various "certificates" may be offered by companies that are not licensed and regulated financial institutions.Check out the terms of the CD:
The penalty for early withdrawal—instead of being measured in months of interest—may be calculated to be equal to the institution's current cost of replacing the money. The penalty for early withdrawal may reduce the principal—for example, if principal is withdrawn three months after opening a CD with a six-month penalty. The institution may specify that the CD may be "called"—i.e. Not good on a CD with a high rate. The institution may not commit to sending a notice before automatic rollover at CD maturity. The institution may not allow the customary five- or seven-day grace period before automatically rolling over the CD to a new CD at maturity. Withdrawal of principal below a certain minimum—or any withdrawal of principal at all—may require closure of the entire CD. Any withdrawal of the interest may be limited to the most recent interest payment rather than the accumulated total interest since the CD was opened. The CD may start earning interest from the date of deposit or at the start of the next month or quarter. If the CD is in a US Individual Retirement Account, a tax penalty is generally charged for withdrawals or closure before the holder reaches a certain age.Brokered CDs
Many brokerage firms – known as "deposit brokers" – offer CDs. These brokerage firms can sometimes negotiate a higher rate of interest for a CD by promising to bring a certain amount of deposits to the institution. Instead of owning the entire CD, each investor owns a piece. If several investors own the CD, the deposit broker may not list each person's name in the title but the account records should reflect that the broker is merely acting as an agent (eg, "XYZ Brokerage as Custodian for Customers"). This ensures that each portion of the CD qualifies for up to $100,000 of FDIC coverage.
In some cases, the deposit broker may advertise that the CD does not have a prepayment penalty for early withdrawal. In those cases, the deposit broker will instead try to resell the CD if the investor wants to redeem it before maturity. If interest rates have fallen since the CD was purchased, and demand is high, s/he may be able to sell the CD for a profit. But if interest rates have risen, there may be less demand for such lower-yielding CD, which means that s/he may have to sell the CD at a discount and lose some of the investor’s original deposit.
Callable CDs
A callable CD is similar to a traditional CD, except that the bank reserves the right to "call" the investment. After the initial non-callable period, the bank can buy (call) back the CD.
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