Deciding On a Certificate of Deposit
An alternative to a regular savings account is a savings certificate, also known as a certificate of deposit (CD) from a bank, savings and loan, brokerage firm or as a share certificate from a credit union. CD’s earn money at a higher rate of interest than savings accounts. By signing up for a CD, you agree to leave money with the savings institution or brokerage firm for a specified period of time. Many factors go into deciding on a certificate of deposit. Below are a few guidelines for finding one.
Minimum Deposit Amount
When comparison shopping for a CD, ask, “What is the minimum deposit amount required?” A typical minimum requirement is relatively affordable and required to earn the institution’s disclosed interest rate and annual effective yield. However, some savings institutions may require minimum deposit amounts that are much more expensive.
Length of Maturity
Typical maturities for CDs are seven to 31 days, three, six, 18, 24, 30, 36, and 48 months. Some institutions offer flexible maturities, allowing investors to select a CD length that matures precisely on the day they have a need for the money. Typically, the longer the maturity and the larger the dollar amount placed in the CD, the higher the yield.
How Often Compounded and Credited
Compounding generally means that interest is being accrued on earned interest. Crediting interest to the CD may be done annually, semiannually, quarterly, monthly, or daily. Some institutions indicate that interest compounds every day, but that the interest is not credited until quarterly, at maturity, or even when cashed in. Other institutions do not pay accrued interest if an account is closed before the interest is credited.
Penalty for Early Withdrawal
Institutions often advertise a “substantial penalty for early withdrawal.” For example, the disclosure statement from one bank revealed a minimum penalty equal to seven days simple interest on a 3-month certificate while another institution imposed a penalty of one month’s interest. On a 24-month certificate of deposit, one institution imposed a penalty of seven days simple interest while another imposed a penalty of three months. If the account does not earn enough interest to cover the penalty, the difference is deducted from the principal of the CD.
Method of Interest Payment
Typically, there are four ways you can receive interest that is earned on a CD.
1) leave interest in the account and add to the certificate balance so that the interest earns interest at the same rate of the CD;
2) have the interest mailed quarterly or monthly in the form of a check;
3) have the interest credited to a checking account (in cases 2 and 3, you are not receiving the benefit of interest compounding on interest); and
4) have the interest credited to a savings account, but the earnings are receiving the lower savings account rate rather than the higher CD rate.
Find out the policy of the financial institution when a certificate matures. Is the money rolled over automatically into a new certificate without changing the interest rate? Such action works to your disadvantage if interest rates have increased. Are funds transferred into a lower-paying regular savings account or a checking account if the money is not rolled over? Are the funds renewed at the latest rate? Does the institution provide notification of an upcoming maturity date? Or are you expected to remember it?
Do the institutions offer other services as incentive to deposit funds with them? There are a lot of benefits for CD holders, ask around and see what services seem most important to you.
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