A certificate of deposit is a safe investment option with predictable returns that protect your principal investment. Because CD accounts earn higher interest rates than most savings and money market accounts, they are appealing to bank customers looking for low-risk ways to build savings.
Although a high-yield savings account, like Ally Bank’s, might offer impressive rates — Ally customers enjoy 1% APY on their savings — this rate is not locked in like it is with a CD.
With a CD account, you won’t lose principal on the money you invest, and your deposits can be insured by the FDIC or NCUA. But not every bank offers rates and terms that suit your personal financial needs. Here are six tips for helping you find a CD savings account that works for you.
1. Consider the Length of Your CD Term
When you open a CD account, you don’t want to withdraw your money early — you agree to keep your deposited money invested for the length of your term whether it’s one month or five or 10 years. While your money is locked into your certificate, you earn dividends based on your interest rate.
If you take money out of your CD before its maturity date, you might be charged an early withdrawal fee. When reviewing CD options, consider how long you can afford to invest your money.
If you’re saving for a short-term goal, such as a vacation or new car, you might want a CD with a six- or 12-month term. But if you’re looking for a low-risk way to build retirement savings, you can opt for a 10-year CD. If you have long-term savings goals but want to have some flexible access to your money, you can build a CD ladder.
2. Compare CD Rates
Before you settle on a CD, be sure to shop around — the goal is to find a high-yield CD with optimal terms for your needs. The main thing to compare is CD account rates because that’s one way you will make money on your deposit. Be sure you know what current rates are before you agree to any terms. Currently, the national average rate for a one-year CD is 0.22% APY for deposits less than $100,000, according to the FDIC. The average rate for a five-year CD is 0.78% APY.
If you invest $10,000 for one year in a certificate earning 0.22% APY, compounded annually, you’ll earn $22 over your CD’s term. Over a five-year CD with a 0.78% APY, you’ll earn a little more than $396 over your term, compounded annually.
The other way you will earn money on your CD is through compound interest. Compound interest is a powerful investment tool as you earn interest on your interest. This means that as your principal earns interest, you will then earn interest on the principal and the interest income, too. This keeps going — that is, compounding — to the terms of your investment or until you withdraw your money.
When comparing the best CD rates, consider each bank’s annual percentage yield. Your APY takes into account how often your interest rate compounds. Your money can compound daily, weekly, monthly or annually depending on your certificate. More frequent compounding can yield higher returns, and you can use a certificate of deposit calculator to see how this interest works.
3. Explore Different Product Types
A traditional CD account allows you to earn money on a fixed rate for your certificate’s term. Other types of CDs offer adjustable rates or certain features that allow you to either bump up your certificate’s rate or access your money before it matures. You might want to consider these other various certificate options.
If rates rise during your bump-up CD’s term, you have a one-time option to upgrade your certificate to a CD with a higher rate. “This option has real value,” said Neil Stanley, CEO and founder of The CorePoint, a service that helps banks and credit unions price and sell loans and deposits. He recommended only trading up if you can get a yield based on the original term of your CD.
The returns on an indexed CD are tied to the performance of a market index, such as Standard & Poor’s 500 index. Indexed CDs can also be tied to bonds, currencies and commodity prices. Although your principal is protected in an indexed certificate, if you end your term early, there’s no guarantee your full principal will be returned.
Callable certificates tend to have longer terms, such as five or seven years. Although callable CDs might have higher rates compared to other certificates with the same terms, a bank can cancel your CD account at any point, ending your term short.
Brokered CDs are CDs which are purchased through brokerage firms rather than banks or credit unions. They are generally FDIC-backed; however, it’s always a smart move to double check. What makes these types of CDs attractive is that they often offer higher rates than bank CD rates. Brokerage firms offer CDs on the primary — new CD — or secondary — meaning someone is selling an existing CD — markets. Brokerage firms usually charge a fee for setting up an account.
4. Look at Minimum Deposit Requirements
Different financial institutions and CD savings account products have different minimum deposit requirements. Your required deposit amount can range from $0 up to thousands of dollars.
CIT Bank, an online bank, for example, offers some of the highest CD rates available. To get in on their 6-month CD with an APY of 0.72% you would need to deposit a minimum of $1000. Keep that same $1000 deposit in for one year and your interest rate jumps to 1.22% APY. There are no required fees, so that’s another bonus.
Chase also requires a $1,000-minimum deposit to open a CD with them. However, Chase’s rates are in stark contrast to CIT, offering customers who deposit $1,000 for six months just 0.02% APY.
5. Factor in Withdrawal Fees
If you withdraw your money before the CD matures or until the end of your term, you will likely be responsible for early withdrawal fees or penalties. These early withdrawal penalties vary by financial institution and brokerage firm, so it’s important you understand exactly what your contract states before you invest in a CD. For example, Bank of America’s fees vary by the terms. For a CD with terms of five years or more, Bank of America charges customers who withdraw their money early an amount equal to 365 days’ interest on the amount withdrawn.
However, a low early withdrawal penalty can be advantageous if interest rates rise and you want to cash out to reinvest. If you have $100,000 in a five-year CD with a 1-percent rate and an early withdrawal penalty of six months of interest, you can expect to pay a fee of $500. If rates rise to 1.13 percent or higher one year after you open your CD account, you might be better off paying the penalty and reinvesting at a higher rate for the remaining four years of your term.
6. Ensure the Deposit Is FDIC-Insured
Any certificate of deposit or CD you invest in should be either FDIC-insured or insured by the National Credit Union Administration. Both the FDIC and NCUA insure CDs up to $250,000 of their value. If your financial institution goes out of business your CD is protected up to $250,000.
You can find out if your financial institution is FDIC-insured by visiting the FDIC website and using their “Bank Find” feature. You can go one step further and check to see which of your accounts are insured by using the FDIC’s online tool “EDIE the Estimator” to verify your accounts are protected.
As you comparison shop CD bank accounts, keep these factors in mind. Find competitive CDs to keep and grow your money. Evaluate your specific financial needs and goals to help you choose the best certificate.
Cameron Huddleston contributed to the reporting for this article.