Frequently Asked Questions about Certificates of Deposit
written by: randalarias•edited by: Stephanie Mojica•updated: 5/24/2011
Find out exactly what a CD is and how it may help you save money. Learn about the five types of CDs, including zero-coupon CDs and liquid CDs.
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What is a Certificate of Deposit?
A certificate of deposit, or CD, is a time deposit that's used banks and credit unions and offered to consumers. CDs are very similar to savings accounts because they can be insured by the FDIC or the NCUA with credit unions. CDs, however, have specific fixed terms and fixed interest rates. Usually you cannot withdraw the money until the term has run out and the CD has matured, at which point you'll get the money along with interest earned. Basically, when you open a certificate of deposit you're giving your bank a fixed amount of money for a set amount of time. When the CD matures, you receive your principal amount back along with interest.
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What are the types of CDs available?
There are five main types of certificates of deposit available. The most common type is the traditional CD, in which you choose a set amount of money which is invested for a preset amount of time at a fixed interest rate. The next type of CD is the bump-up CD. This is for people that are afraid of rising interest rates and allows a one-time option to bump-up your rate. Usually, your initial interest rate will be lower when you choose a bump-up certificate of deposit. The third type of certificate of deposit is the liquid CD that allows you to withdraw funds without a penalty. The interest rate for liquid CDs will be significantly lower because of this. There's also a zero-coupon CD, which means you buy the certificate of deposit at a discount to par value, which is the amount of money you receive when the CD matures. Basically, with a zero-coupon certificate of deposit you'll get no interest payments until the CD is matured. The last type of CD is the callable certificate of deposit. This means that the bank can call back the certificate of deposit if they begin offering lower interest rates, lowering the rate you're receiving. If they do so you'll receive the full amount of your principal and interest earned to date. Agreeing to a callable CD will usually give you a better interest rate.
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What are the guidelines for interest rates?
Guidelines will vary depending on the institution and type of CD you purchase. In general, a larger interest rate is given for higher principals. Longer terms also give higher interest rates. The best rates are usually available at smaller institutions rather than large companies. In addition, personal certificate of deposit accounts receive better interest rates than business CD accounts and banks and credit unions that don't offer FDIC and NCUA insurance provide better rates.
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How do you buy a CD?
You can buy certificates of deposits through your bank, credit union, or a brokerage firm. When you decide to buy a CD you'll need to decide on the duration of term. Usually, a longer term earns a higher interest. Secondly, you need to decide what type of CD to buy. You can choose from a traditional CD, a bump-up CD, liquid CD, zero-coupon CD, or a callable CD.
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How do you cash out and close a CD?
When your certificate of deposit reaches maturity, you'll usually be sent a letter from the institution asking for directions from you. You'll usually have the choice of withdrawing the principal and interest or rolling over the certificate of deposit into a new CD. If you don't give directions, the bank will usually roll over the CD automatically.
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What happens if I withdraw money before the CD matures?
If you withdraw money before your certificate of deposit matures you'll face a large penalty. For example, if you have a 5 year CD and withdraw early you'll face a loss of six month's interest. The penalties are agreed upon when you open a CD and cannot be revised once the deposit has been made.
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What is the ladder strategy?
The ladder strategy involves distributing your money and deposits over a long period of time, achieving the best interest rates for each certificate of deposit and ensuring that CDs mature throughout the year.