Certificate of Deposit - Tips for Savers

By Rita Lowman

Investors seeking a low-risk investment that can be easily converted into cash often choose a certificate of deposit (CDs), a special type of deposit account with a financial institution that offers a higher rate of interest than a regular savings account. 

When an investor purchases a CD, he or she invests a fixed sum of money for a fixed period of time, such as six months, one year or more.  In exchange, the issuing bank pays interest to the investor typically at regular intervals.  When the investor cashes in or redeems the CD, the bank pays back the money originally invested along with accrued interest.  However, if the investor redeems the CD before it matures, the investor may be required to pay an “early withdrawal” penalty or forfeit a portion of the interest earned.

Traditionally, most investors have purchased CDs through local banks, although many brokerage firms now offer CDs as well.  The CDs offered by FDIC insured banks insure your deposits up to $250,000 per account holder.

CDs once just paid a fixed interest rate until they reached maturity.  But like many other products in today’s market, CDs have become more versatile.  Investors may often choose from variable rate CDs, long-term CDs, and CDs with special features.  The special features may be a CD that has the option for the rate to be “bumped up” once during the life of the CD should the rates increase. 

Some of these long-term, high-yield CDs have “call” features, according to the Federal Deposit Insurance Corporation (FDIC).  This means that the issuing bank may choose to terminate – or call – the CD after only a year or other fixed period of time.  The investor does not have this option. 

Before purchasing a CD from a bank or investment firm, it is important to fully understand all of the terms.  Make sure to read disclosure statements, including the fine print.  The following tips may assist investors in assessing what features make the most sense:

•  Make sure to confirm the maturity date on a CD.  Believe it or not, investors have been known to tie up their money for years because they did not understand the maturity date.

• Investigate all features of the CD. Callable CDs give the issuing bank the right to terminate the CD after a set period of time; however the investor does not have the same right. Investors should receive the full amount of the original deposit, plus any unpaid accrued interest, if a bank redeems a CD.

• Understand the difference between call features and maturity.  Some investors make the mistake of assuming a fixed maturity date and the call feature may state something different.  Investors should clarify with the banker or salesperson at the bank or investment firm a CD’s call features and its date of maturity.

• Investors should confirm the interest rate they will receive and how they will receive payment.  Investors should receive a disclosure document explaining the rate of interest on the CD and whether the rate is fixed or variable.  Also, the bank should explain how the payout will be received – by check or electronic transfer of funds.

• Research penalties for early withdrawal.  An investor should know how much would be required for cashing a CD in prior to maturity.

• Investors should be informed about any other additional CD features, such as a death benefit that will allow a CD owner’s heirs to redeem the CD without penalty if the owner dies.

• When purchasing a brokered CD, identify the issuer.  Federal deposit insurance is limited to a total of $250,000 to each depositor in each bank or thrift.  Therefore, investors should be clear about which bank or thrift will issue the CD, or where the deposit broker plans to deposit the money.  Investors should be assured that his or her CD will have FDIC coverage

Ask the questions and be informed before you invest your money!

Rita Lowman is the Executive Vice President / CAO of American Momentum Bank.
American Momentum Bank is a progressive Florida-based bank that strives to offer a deep understanding of our commercial, and retail clients’ immediate and long range goals. For more information, please visit www.AmericanMomentumBank.com.