What is a Certificate of Deposit?

With a Certificate of Deposit (CD), you agree to deposit a specific amount of money for a fixed period of time (this is called the maturity). In return, your financial institution agrees to pay you interest. Usually, they offer higher interest than regular savings accounts. CDs limit opportunities to access these funds. Only use CDs for cash you don’t anticipate needing until after your CD matures.
 
Your bank will offer you many different maturities or terms for CD’s. They include 3 months, 1 year, 2 years, 5 years, etc. Generally, you will find that the longer the term of the CD, the greater the interest rate. There is a catch. If you lock your money in at today’s CD low rates, and then rates go up, you missed out on the higher rates.
 
When you buy a CD you are locked into that interest rate for the life of the CD. If you take out your money before the full term, the bank will charge you a penalty. You must be sure you understand the term and the penalties involved. What happens if you need the cash and you have to “bust” your CD. Also, consider which direction you think interest rates are heading. If interest rates are very low, don’t lock in a low rate for 5 years! You can’t bust your CD and then buy a new one with a higher interest rate if you’re current CD hasn’t matured yet.
 
On the flip side, you are guaranteed to get a fixed rate of interest on your money for the complete term of that CD. So, if rates are high, then it might be wise to lock in the higher rates for longer terms.
 
The last time there were high-interest rates in the U.S. was the 1980’s. At that time the rates on CD’s were as high as 18%! Now, interest rates for CDs are very low: 2% for a one year CD and just 3% for a five year CD.

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