Certificates of deposit offer stable investments with predictable returns, but you should understand the terms and features of a CD before you deposit funds.
From interest rate earnings to early withdrawal penalties, ask yourself these questions before you open a CD.
1. What Interest Rate Will I Earn?
A CD’s interest rate determines how much you’ll earn from your deposit, so the interest rate is a critical factor when you choose a CD. The rate will vary depending on the financial institution, term length, features and market interest rates.
Usually, CDs offer a fixed interest rate that doesn’t change for the entire CD term. Variable-rate CDs are less common and have a rate that can change over time depending on an underlying benchmark rate. Your rate could increase with a variable-rate CD, but it could also decrease.
Ravi Kumar, head of CIT Direct Bank, a division of First Citizens Bank, encourages looking beyond CDs when comparing interest rates. “Look at high-yield savings accounts vs. CDs and know what options are available to you,” Kumar says.
2. How Long Is the CD Term?
The term length of a CD is how long your money must stay in the account before you can access it without penalty. CD terms can range from a few months to five years or more. Short-term CDs under a year may offer lower interest rates with quicker access to your deposit, while a long-term CD may offer higher interest rates but require you to keep your money locked away longer.
Choosing the right term length might come down to your savings goals and the interest rates available with various terms. For example, if you’re saving for a short-term goal like an upcoming vacation, a short-term CD may be a good choice. A long-term CD can support long-term goals like saving for a house down payment, but a shorter term can make sense if you might need access to your money before the CD matures.
“The longer the CD, the more you should be paid,” says Mark Fried, wealth manager and partner at Merit Financial Advisors. “This is not always the case.” Fried recommends getting the best interest rate for the shortest term.
[Read: Best CD Rates.]
3. What Are the Penalties for Early Withdrawal?
CDs typically have early withdrawal fees, which are penalties that can significantly reduce your interest earnings if you need to access your funds before your CD matures. Generally, early withdrawal penalties are calculated as forfeited interest. The penalty amount depends on the CD’s terms and how early you withdraw your funds. For example, you might lose three months of interest when you withdraw early from a one-year CD.
Understand early withdrawal penalties and plan liquidity needs before you open a CD. If you’re not confident you’ll make it to the end of a long term without needing access to your money, a shorter-term CD may be helpful. You can also consider a no-penalty CD, which may have a lower interest rate but allow you to withdraw your funds early without penalty.
“Never put your money in a CD where you could possibly lose principal if you take your money out early,” says Fried. “Always ask for a detailed description of the penalty before placing money into a CD.”
4. What Is the Minimum Deposit Requirement?
A CD’s minimum deposit requirement is the lowest amount of money you can contribute to open a CD. The amount varies between financial institutions and CD products. Generally, minimum deposit requirements for CDs range from $500 to $2,500, but some may require a larger deposit. If you can’t meet the minimum deposit requirement on a CD, consider a high-yield online savings account that may have a lower or no minimum deposit requirement.
[See: Best High-Yield Savings Accounts]
5. What Happens When the CD Matures?
When your CD’s term is complete, it” considered mature. You can renew, withdraw or reinvest your CD funds at maturity. CDs generally have a grace period of seven to 10 days after maturity, when you can make changes without penalty. Usually, banks automatically renew CDs into a new CD at the same term length unless you indicate otherwise.
“Banks are notorious for having very short renewal periods,” says Fried. “Many CD depositors inadvertently miss the window and find their money locked up in another CD, often at a much lower rate.”
The renewal interest rate is based on market rates at the time of renewal and may be higher or lower than the original rate.
“Most promotional rate CDs are rolled into a second term,” says Kumar. “Read the disclosures and understand where you stand when the CD matures, as the promotional rates might be high but the rate for the rollover term might be lower.”
6. Are There Special CD Features?
Some CDs have special features that can add flexibility and greater interest earnings, including bump-up or step-up CDs, add-on CDs, no-penalty CDs and jumbo CDs. For example, a bump-up CD allows you to increase your interest rate if the bank offers higher rates for new CDs during your CD’s term, while add-on CDs allow you to make additional deposits during your CD’s term.
7. Can You Open Multiple CDs?
Depending on minimum opening deposits and your savings budget, you can open multiple CDs. CD laddering is a common reason for opening multiple CDs. With CD laddering, you can spread your money over various CDs that have different maturity dates and get regular access to your funds. As each CD matures, you can withdraw or reinvest the funds.
8. How Does Inflation Affect Your CD?
CD returns don’t always keep pace with inflation. If you lock in a CD during a high inflation period, your money might lose purchasing power. Although interest rates may go up during higher inflation periods, you can’t benefit from higher interest rates until your CD matures and you invest it in a new CD.
Fried recommends considering interest rate risk, which is whether interest rates are rising or falling. “If interest rates are falling, you may want to get a little longer term because when your CD renews, you may not be able to get as good a rate as the initial deposit,” says Fried.
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8 Things to Know Before Opening a Certificate of Deposit originally appeared on usnews.com
