What is a Certificate of Deposit?

A certificate of deposit, also called a CD, is a type of savings certificate. A client deposits a certain amount of funds with a bank for a fixed period, usually from one to five years although longer terms are possible, and in return is guaranteed a locked interest rate which is higher than that of a traditional savings account. For people who want non-risky methods of investment with guaranteed returns, such as the elderly, youth wanting to set money aside, or people with limited funds, a CD is an excellent investment alternative, because when it is held by an Federal Deposit Insurance Corporation (FDIC) insured bank and is for less than $100,000 US Dollars (USD), the client will never lose his or her money.

A certificate of deposit can take a wide variety of forms which are negotiable with the issuing bank. If it is under $100,000 USD, it is known as a “small CD,” while deposits over that amount are called “jumbo CDs.” A jumbo CD is somewhat more risky, because the FDIC cannot ensure it, but is still a sound investment when made with a reputable bank. After the amount of deposit is decided, the term of the CD is determined: this can range from six months to 20 years, and it is very important to understand the length of the term before signing paperwork, because you will pay a penalty for withdrawing funds early. Finally, an interest rate can be locked in. Depending on the market, it may be possible to secure a very favorable interest rate, although if the market improves, the interest rate will remain the same, unless a variable interest rate has been agreed upon. Generally, the longer the term, the better the interest rate.

There are a few things to be cautious of when setting up a certificate of deposit. The first is whether it is “callable” or not. If it is callable, it means that the bank can terminate it, forcing the client to establish a new CD, whether at that bank or another. Unfortunately, these certificates are usually called when interest rates drop, meaning that the client loses the high rate of interest that he or she has negotiated. Clients, of course, cannot call their CDs, and are locked in at the agreed upon rate and terms until the deposit matures. It is also important to understand how the interest rate works, including when it is applied and whether the interest is fixed or variable.

Finally, it is important to make sure that you get a certificate of deposit from a reputable and FDIC or Federal Reserve insured source. If you are using a broker, check to make certain that you know which bank is issuing the certificate, and that the bank is insured. You should also check out the broker with the chamber of commerce, to make sure that he or she has not been involved in fraudulent activity. You can also check with the securities regulator for the state in which the broker works.