As a rising senior, I’m beginning to think more and more about budgeting and finances. As we get sent out into an uncertain job market, we start to prioritize saving money over takeout and nights out. Suddenly we yearn to become more frugal. We say no to impulsively buying that trampoline you know you’ll never assemble. We begin to pay more attention to words like “interest” and “principals,” and start scheming of ways to use our money to make money. Taking out a certificate of deposit, or “CD,” accomplishes this goal. This term may seem familiar to you. What is a certificate of deposit, and how can it benefit you financially?
Keep reading to learn all about CDs and how they can earn you money with little effort on your end.
What is a certificate of deposit?
“A certificate of deposit is a savings product or vehicle where the client agrees to let the bank hold his/her money for an agreed upon amount of time in exchange for the bank paying a pre-determined rate of interest. Rates are set based on current market conditions,” said BB&T Vice President Christopher Zienty. Essentially, the customer who agrees to take out a CD agrees to let the bank handle their money for a certain period of time. The bank uses this money as they see fit, usually distributing it out as loans. In return, the bank pays extra for their right to hold onto the customer’s lump sum for a certain amount of time known as a “term.” Once the CD reaches the end of its term, or “maturity,” the customer takes out his money along with the accrued interest.
How difficult is it to open a certificate of deposit?
Some investments, such as breaking into the stock market, require confusing steps such as faxing info all over the nation and pleading with customer support for hours just to secure an account. It almost makes you wish you accepted the risks that came with taking money from that loan shark or poured more money into buying lotto tickets. Luckily for all of us, “Opening a CD proves actually quite easy. The process remains similar to opening a checking or savings account. An account number is assigned by the bank, an initial deposit is made, and the legal document/contract is signed by the client agreeing to the terms of the CD,” said Zienty.
However, once your term starts, you can’t touch your CD money, lest you cancel the account prematurely. Ensure your financial stability before proceeding. You can’t gamble away all your money on the Vegas ultimate frisbee trip and pay your rent and expect to not dip into your CD funds unless you’re stable or possess a really good poker face. You’ll also need to meet the minimum deposit requirements which can be anything from $500 to $1,000. Also note that smaller institutions tend to offer higher interest rates than large conglomerates to foster fidelity.
Understanding Standard Length Terms
Term lengths vary depending on the interested customer’s agenda. They can be as short as one month (though you’ll gain basically zero interest here) to full 10-year terms. The standard range of options stands between three months and five years. Remember, the longer the term, the more interest is earned.
The benefits and risks of a certificate of deposit
The Federal Deposit Insurance Corporation (FDIC) insures up to $250,000 of your money, making the endeavor basically risk free. Taking out a CD greatly benefits you as a customer, so long as you don’t need the money during your term length. A one year term at a 2.50% Annual Percentage Yield, or APY can earn you hundreds of dollars, whereas an average savings account will earn you almost 1% less interest. That would equate to almost $400 at the end of the term if you go with the CD option. You could buy a music festival ticket for that or about 44 Barefoot Pink Moscato Rosés. Or 400 snickers bars in bulk. Or you could pay off that loan shark from earlier. Or simply invest further into a CD with a longer term, now that you got the feel for it.
Cancelling a Certificate of Deposit Prematurely
With the maturity date fixed, you can only get your money back if you cancel prematurely, or before the term length ends. “If absolutely needed a client can break/close their CD early. In most instances the client would incur a penalty in doing so. Penalties may range from as little as $25 to forfeiting 3, 6, or 12 months of simple interest earned depending on the initial length/term of the CD opened,” said Zienty.
For a five-year CD, expect to lose up to 12 months of interest. These steep penalties ensure that the customer’s money stays in place before maturity. Unless you have an investment with the promise of a significantly higher return, or you seriously need the money, don’t cancel prematurely. Be patient, because if you invested smartly, it’ll all pay off soon.
What are the different kinds of Certificates of deposit?
Bump-up CDs: These CDs start out with lower interest rates than fixed rate CDs, with larger minimum deposit requirements. However, you can request a higher rate (or bump it up) if you bank increases its APY. Shorter terms usually hold room for only one request.
Step-up CDs: CDs with rate increases that occur organically, as APYs automatically increase at fixed intervals.
Low risk/no penalty for early withdrawal CDs: A more liquid CD, these low risk agreements allow you greater access to you money, but provide lower rates of return than traditional CDs.
Business/Jumbo CDs: As students, we don’t have to worry about this. However, for all you big picture thinkers, Jumbo CDs require at least $100,000 minimum balance requirement, and thusly yields a higher return rate.
Consider taking out one of these certificates of deposit to put money in the bank and make it work for you while you’re gone.