Did you know that your savings could earn even more money for you? Certificates of deposit—also known as CDs or CoDs—are a special type of savings account with a guaranteed rate of return over a certain timeframe so you can give your savings a raise even while you sleep! Learn everything you need to know about CDs in this article.
How Certificates of Deposit Work
A person opens a CD by depositing money into the account for a fixed period at the interest rate the financial institute is currently offering. Said another way, certificates of deposit earn interest on a lump sum deposit for the agreed-upon period.
Let’s say a bank or credit union offers a two-year CD at 2% interest with a minimum initial balance of $1,000. If someone opens a CD under those conditions, then the interest will accrue on the balance they deposited based on that fixed rate for two years.
Additionally, you’ll often see an associated annual percentage yield (APY) also in percentage form. The APY^ takes both the interest rate and the effect of compound interest into account and assumes no early withdrawals. Compounded interest means that you’ll get interest on your balance/principal—but also earn interest on interest. In other words, you’ll earn more interest.
CDs with shorter terms typically pay a lower rate of interest than ones with longer terms. If interest rates drop in the middle of the CD’s term, the CD interest rate stays the same; the same is true if CD interest rates increase during the term. Let’s take a look at an example:
- Initial Deposit: Let’s say you open a CD with a $5,000 deposit.
- Term: Because you won’t need the funds for a while, it’ll be for a 60-month CD.
- Interest Rate: The interest rate is 3.14% APY^, which is higher than savings rates.
- Earnings: Over that 60-month period, you’ll earn $835.87—so, at the end of your term, you’ll now have $5,835.87.
Our CD calculator can help you calculate how much interest your CD will yield upon maturity.
What You Can Do with a CD Upon Maturity
When the CD term expires (on the CD’s “maturity date”), the depositor has a couple of different options:
- withdraw the money (usually moving the funds into a checking or savings account)
- renew the CD at the same term (different interest rate may apply)
- roll the money into a CD at a different term and interest rate
Although the interest rate is locked in when the depositor opens a new certificate, CD interest rates may well continue to fluctuate during that timeframe based on financial benchmarks. Although this would not affect someone who has a CD rate locked in, it does impact people opening new ones.
At Space Coast Credit Union (SCCU), we offer CD terms between 3 and 60 months (5 years). Here, you can
open one or more certificates of deposit at SCCU.
Difference between CDs and Savings Accounts
Certificates of deposit differ from regular savings accounts because the money must stay in the CD throughout the agreed-upon term. If not, then the account holder may face a penalty or early withdrawal fees based on the initial agreement at the time of opening. Because these requirements exist, CDs typically pay a higher interest rate than regular savings accounts. Also, you can’t make additional deposits to the CD.
CDs are attractive for people who want to earn more money than they’d get in a typical savings account while still having a safe way to save their money. You might, for example, want to avoid the volatility of the stock market, and CDs will allow you to accomplish that.
How Certificates of Deposit Became Safe Investments
This type of account existed in Europe as far back as the 1600s. One of the forms of European banking involved a banker taking in deposits, giving the depositors a receipt for the amount of money involved. Banks then used the funds to make loans to merchants, charging them interest. Then, bankers created an interest rate that they would pay the people who deposited the funds, one that was less than what they charged the merchants taking out loans. That’s how the bankers themselves made money on the transactions. Although it's not precisely like the modern version of a CD, it serves as the foundation of the concept, a precursor to modern banking.
In the United States, this type of savings product became available in the early 19th century. Depositors would literally receive certificates that were elegantly embossed with the terms of their agreement connected to their investment. Nowadays, the physical certificate is less ornate, most likely a printed agreement of the amount, rate, and term, and conditions of the account.
Rates paid for CDs have fluctuated significantly over the decades. Before the Federal Reserve was created in 1913, no oversight organization existed in the United States to provide regulation or consistency of financial institution structure. In that era, banks were privately owned and might offer the best CD rates around—but, before federal insurance existed for deposits, the private banks may not be able to keep up their end of the deal. So, depositors may have been offered highly attractive interest rates but not actually receive those funds as promised.
The establishment of the Federal Reserve Act in 1913 provided more uniformity to the U.S. banking system, mandating that financial institutions maintain a certain amount of reserves to meet their commitments even when economic conditions became more challenging. The Federal Reserve Act created a more secure system than before but not as secure as it is today. The modern system didn’t become established until after the stock market crash in 1929—when many people lost the money that they’d put into stocks and, often, bank accounts. In 1933, President Franklin D. Roosevelt signed the Banking Act into law, which created federal insurance coverage for people who deposited their money into federal banks.
Benchmark-wise, what the Federal Reserve has set as the federal funds rate can influence what a financial institution will offer on their CD products. Each financial institution can independently set their rates and terms; they will not be the same across all banks and credit unions.
American banks became insured through the Federal Deposit Insurance Corporation (FDIC), and federal credit unions became insured by
National Credit Union Administration (NCUA). That’s how CDs gained the level of safety and security that they now enjoy. Deposits made at SCCU are insured by at least $250,000 per individual depositor by the NCUA. SCCU members and members of other federally insured credit unions have never lost money in insured savings, which includes CDs.
Today’s certificates of deposit are a guaranteed, non-volatile form of savings. Their interest rate is fixed and locked in upon opening the CD. The interest rate given then is what you’ll receive throughout the agreed-upon term. So, as long as you don’t make an early withdrawal and trigger penalties and/or fees, you can count on receiving the interest amount you’ve signed up for.
What to Consider When Looking to Open a CD
Insurance: If you’re looking to invest in a CD, what’s most important is to make sure that the financial institution is federally insured so that you can proceed with confidence knowing that your funds are protected. Although most financial institutions are federally insured, some are privately insured.
Deposit Amount: Then, you’ll want to consider how much money you want to invest. Because you can’t withdraw any funds from certificates of deposit before their maturity date without some sort of penalty, you’ll want to deposit only the amount of money that you can afford to keep in without touching it.
As a rule of thumb, you shouldn’t deposit your emergency savings into a CD, as those funds aren’t accessible without facing fees. However, if you’re saving for a house, you might put those funds into a CD with a term that would mature before you would need them for a down payment or closing costs.
When saving for something big in the future, you might decide to open a CD with some funds you have in savings account so that you can earn interest on that amount while you continue to deposit funds in a separate account. When the CD matures, you could take the funds currently in your savings account; put them into your CD for a new term, and continue to save in your savings account. You can repeat this process for as long as you’d like, earning a higher interest on the funds in the CD.
Rate and Terms: You’ll want to get the best CD rates you can while considering the caveats about choosing the right term for your needs. When comparing CDs from more than one financial institution or within the institution itself, the APY^ provides an apples-to-apples comparison for the CD. Financial institutions are not required to compound interest but, when they do, it offers a better deal for depositors; at SCCU, we compound interest.
Choosing the right term can take some strategy. You’ll want to go through the steps listed above, but then you might also factor in what CD interest rates are expected to do. If, for example, interest rates are expected to go up soon, you might deposit funds into a short-term CD to have them available to reinvest when the anticipated higher rate arrives. Under other economic conditions, you might expect CD interest rates to be going down soon. In that case, you might lock in the higher rate that goes along with a longer-term CD. Remember that, the longer the CD’s term, the higher the rate will likely be.
Certificates of Deposit at SCCU
At SCCU, you can open a CD with as little as $500
6 for whichever term you choose, with your funds federally insured by NCUA up to $250,000. Plus,
compared to the national average for CD rates, we have some of the
best CD rates in Florida. Available terms and interest rates include: