What is a Certificate of Deposit and How Does it Work?

When you open a Certificate of Deposit (CD), you agree to leave their money in the account for a period ranging from a few months to several years. In return, banks or credit unions offer a higher interest rate than regular savings accounts making it a great way to store and increase your money. CDs are a smart option for those planning a large future purchase like college, a downpayment for a home, or a vehicle. This article’ll explain what a CD is and how it works.

What is a Certificate of Deposit (CD)?

So, what is a Certificate of Deposit? Also known as CD, multiple financial entities, like banks and credit unions, offer a Certificate of Deposit. It is a deposit account that mandates the account holder to deposit funds for a particular time frame until a maturity date. The account pays a variable or a fixed interest rate for the specific maturity period depending on the type of Certificate of Deposit chosen. The interest rate varies by the length of the tenure and the funds deposited. The time frame is usually between three months to five years. If account holders withdraw the amount before the maturity date, they encounter penalties and fines.

Working Mechanism of a Certificate of Deposit

Deciding on How Much to Invest

The first step is determining the amount one can invest in a Certificate of Deposit. This is vital because Certificates of Deposit are not liquid money that investors can utilize during emergencies. Investors should deposit only the amount they are sure not to withdraw before the maturity period. A Certificate of Deposit charges early withdrawal fines or penalties, making it a bad pick for emergencies.

Determining the Type of a Certificate of Deposit Investors Want

The good thing is that most banks and credit unions in the US offer one type of Certificate of Deposit. Further, the leading and big financial institutions offer an extensive range of Certificates of Deposits. Three parameters come into the limelight when picking a Certificate of Deposit.

1. The first parameter is the tenure or the time investors want to leave their money in a CD account before withdrawing. The tenure ranges from a few months to several years, giving options for short-term and long-term investments.
2. Interest rate is critical when choosing a Certificate of Deposit. The top-paying Certificates of Deposits usually pay more than the average interest rates in the country. Further, longer tenures indicate that account holders are getting higher interest rates.
3. Selecting between a standard and a variable Certificate of Deposit is another parameter. Standard Certificates of Deposits abide by specific interest rates and charge penalties and fines for early withdrawals. Further, special CDs have flexible or variable interest rates with lower interest rates, like liquid Certificates of Deposits.

No Early Withdrawals

Apart from understanding what a certificate of deposit is, account holders shouldn’t consider the money after opening the account. Experts recommend that account holders restrict themselves from withdrawing the funds before maturity. Early withdrawals attract penalties and are often beyond the interest earned over the years.

Decisions and Plannings During the End Term

When a Certificate of Deposit reaches the end of its tenure or maturity, account holders should make suitable decisions.

Rolling the Account Into a New CD Account

Depending on the banks and credit unions, account holders can roll the Certificate of Deposit into a new account following the same or different tenures.

Transferring Funds Into Another Account

Account holders can transfer the matured CD funds into another account at the same banks or credit unions through money market accounts, checking, and savings.

Proceeds Withdrawing

Account holders can request the banks or credit unions holding the Certificate of Deposit to transfer the funds to accounts at different financial institutions.

Without specific instructions, the financial institutions holding the CDs after maturity automatically roll over the amount at the same interest rates and terms.

Conclusion

The article details a certificate of deposit and its functioning mechanism. As a guide, it helps people understand how to begin with CD accounts and what to expect.