The return you'll receive on a CD depends on the financial institution that issued it, the amount of your deposit, and the length of the term. Smaller financial institutions tend to pay a little better than larger institutions, and larger deposits and longer terms tend to earn a better interest rate, but not always. According to Bankrate.com, the average current rates in the U.S. are 3.13% for six months, 3.61% for one year, and 4.17% for five year terms.
Minimum deposits for CDs will depend on the issuing financial institution; many require a minimum deposit of $500-$1000. Terms also depend on the issuing financial institution; some have CD terms as short as seven days, but CD terms most commonly range from thirty days to five years. Very long-term CDs may mature in ten, twenty, or thirty years, but there are better places to put your money if you are willing to tie it up for that long.
CDs have early withdrawal penalties.
It's important to be able to commit your money for the length of the agreed upon term; early withdrawal penalties will apply if you must withdraw your money before the CD's maturity date. These penalties can eat away the earnings, and you'd probably be better off leaving your money in a regular savings account if you feel you may need the money before the CD matures.
Using Bankrate's current average rates as an example, you would only earn just over one additional percentage point by committing your money for five years versus six months. And a lot can happen in five years' time; some people meet their true love, get married, and have a child within that time-frame. Consider whether there's a possibility that you may need the money before the maturity date before you commit to the term. For that reason, it's generally safer to invest in shorter term CDs, unless you have substantial, liquid savings elsewhere.
The maturity date is when the CD can be cashed in without penalty, but you are not required to cash it in at that time. Most financial institutions will roll your funds into a new CD with the same term as the first, but the interest rate may change according to current rates.
Some people stagger, or ladder, maturity dates with several CDs, so they always have a CD they can cash in, without penalty, if they need to. This can be a good way to manage emergency fund savings, college tuition expenses, or other money that you may need to access at regular intervals.
CDs may have a call feature.
Some long-term, high-yield CDs are callable, meaning that the issuing institution can call, or terminate the CD after a set period of time. This right is reserved for the issuing institution, and protects them from paying a higher rate for an extended period of time when the current rates are lower. This feature does not protect the investor.
For example, a CD may have a five-year term, but be callable in one year. The issuing institution may take advantage of this right if the interest rates drop; they will pay you your principal plus the the accrued interest up to that point, but you'd miss out on the remaining four years at that rate and would have to invest in a CD at the current, lower rate or find someplace else to put your money.
It's important to understand that a call feature has nothing to do with the maturity date. Scams of the past involved sales of very long-term CDs to elderly investors who, due to their age, were not likely to live to see the maturity date. These CDs typically had a very expensive early withdrawal penalty, upwards of 25% of the principal, and disclosure of these costs were often minimal. Unscrupulous brokers took advantage of misinformed investors who confused a call feature with the length of the term.
The Alabama Securities Commission reports an incident several years ago, involving a retiree in her 70's who invested over $100,000 of her 97 year-old mother's money in three CDs with 20-year maturities. The investor told the broker that her intention was to use the money for her mother's nursing home care. She didn't understand that the one-year call feature meant that only the issuer had the right to cash in the CD without penalty.
As with any investment, it's important to fully understand all the details before you commit your money to a CD:
- Know the term. As simple as it sounds, many investors fail to confirm the maturity date, and are later shocked to find out they've tied up their money for five, ten, or even twenty years. See it in writing before you purchase any CD.
- Investigate and understand any call features. This is also something to see in writing. In CDs with a call feature, a CD is more likely to be called if interest rates go down because it will save the institution money; they'll be happy to continue to pay you the lower rate you locked into for the remainder of the term if interest rates go up.
- Identify the issuer if you purchase CDs from a broker. Your CD deposits are insured up to $100,000, but you may risk some of your investment if you already have deposits or CDs with the same institution, and the CD investments put you over the $100,000 insurance limit. It's best not to exceed $100,000 in any one financial institution for FDIC or NCUA protection.
- Find out how the CD is held. Unlike traditional bank CDs, some brokered CDs are held by individual, unrelated investors who may each own part of the CD, rather than one investor owning the entire CD. If several investors own the CD, the broker will probably not list each owner's name in the title. But you should make sure that the account records indicate that the broker is merely acting as an agent for you and the other investors, to ensure that each investor's portion is protected up to $100,000.
- Research and understand any early withdrawal penalties. Some CDs may, technically, have no early withdrawal penalty, but it is still possible to lose money if you cash in that type of CD before the maturity date if interest rates have risen since the purchase. There will be less demand for your lower-yielding CD, so you may have to sell it at a lower price, at a loss of principal.
- Thoroughly check out the broker. Deposit brokers do not have to go through any certification or licensing procedures, and no state or federal agency examines, licenses, or approves them. Anyone can claim to be a deposits broker, so check to be sure there aren't complaints or reports of fraud involving your broker or the company they work for. Call your state securities regulator, or the National Association of Securities Dealers' "Central Registration Depository" at 1-800-289-9999.
- Confirm the interest rate and how you will be paid. Check whether the interest rate is fixed or variable. If it is variable, find out how often the rate can change and whether the rate is tied to an index. Find out how often your interest payments will be made, whether monthly or semi-annually. And find out if they will pay by sending a check in the mail or by electronic transfer.
Securities and Exchange Commission