Personal Finance

Know how a certificate of deposit works

Certificates of deposits – in US – are interest bearing time deposits issued by banks, brokers or thrift institutions. It is similar to a deposit account with any of these financial institutions but has a higher interest rate than a typical savings account. A CD is insured by Federal Deposit Insurance Corporation for banks and National Credit Union Administration for credit unions. CDs are more popular with people who are straight forward and those looking for low-risk investments.

Let us see how a Certificate of Deposit works. To purchase a CD, one need to invest a particular amount of money with the bank or thrift institutions, for a definite period of time – 6 months, one year, three years, or more – and in exchange, the issuing financial institution pays an interest, generally in regular intervals. When the depositor redeems the CD, after the timer period, he/she gets the amount which was originally deposited plus the interest accrued over the time period. On the other hand, if the deposit is withdrawn earlier than the maturity date, a penalty that amounts to a portion of the accrued interest will be levied on the depositor.

Traditionally CD’s offered a fixed interest rate through out its term. But, as the competition in the sector increased, now CDs are available in various types such as variable interest rates, long term, high yield CDs, discount CDs and small savings CDs. But before jump into buying some CD, make sure that you are thorough with all its terms and conditions. Carefully peruse the disclosure statements and fine print. Also, don’t get carried away by the high yields offered.

These tips can help a prospective depositor in assessing the deal effectively.

  • Have a clear and sound idea about the maturity date. The idea is to get back the amount and interest after a certain time period that suits your requirement. Sounds simple, but this is an area where many people make mistakes. Before getting the CD, specifically ask to see the maturity date in black and white.
  • Find out if the CD has any call features. Such CDs give the banks the right to terminate a CD after a set period of time, if, for example, in instances like when the interest rates fall. But banks won’t empower the customer with such privileges.
  • Clearly discern the differences and use of terms like ‘maturity’ and ‘call features’. The terms can be misleading. For example, “federally insured one-year non-callable” CD doesn’t mature in one year. Look out for verbal juggleries.
  • Identify the issuer if the CD is a brokered CD. Also find out how the CD is held. Ask for a copy of the exact title of the Certificate of Deposit.
  • Have a good idea about the penalties levied for early withdrawals, especially if you are getting it from a deposit broker.
  • Check out the authenticity of the deposit broker. Remember, they don’t have to pass through licensing or certification procedures nor any exams or federal or state agency licenses.
  • Confirm the rate of interest and mode of payment. If one is selecting a variable rate CD, have an idea about when and how the rate will change.

The bottom line is that, which ever scheme you enroll in, it should make sense to you. It should be useful to the depositor in some way or the other. After all, saving is not accumulating money alone, but doing so for a definite purpose on a later date. A 15 or 20 year term may be useful for youngsters who wish to diversify their financial holdings. But such a scheme will be of no use for elders. It is the way the logic goes.

Also, there is no need for one to lose heart even if you have invested in a long-term, brokered CD under a mistaken belief that it was a short-term deal. In the occurrence of such a case,

  • Talk to the broker who has sold the CD.
  • If that doesn’t work, take the complaint to the branch manager.
  • Write a note to the compliance department at the financial firm’s head office.
  • Also, contact the banking regulator who supervises the bank which has issued the CD.