Certificate of Deposit Basics: How Do Bank CDs Work?

by Silicon Valley Blogger on 2009-08-1416

Where to put your cash beyond the standard high interest savings accounts?

When she was still alive, my grandmother loved bank CDs. She put all her money in various certificates of deposit housed in a variety of banks and that was pretty much the extent of her “investment portfolio”. This was to be expected since the equity markets in my native country were often too volatile for our taste, so certificates of deposit, bonds and real estate were the investments of choice of most people.

Following her footsteps, I made my first real investment outside of high yield savings accounts in certificates of deposit and money market funds. I put what I considered to be my first significant amount of savings into time deposits (another name for CDs), which I figured were simple enough financial products that carried no risk and would return me my principal plus interest after a certain amount of time.

Popular Certificates of Deposit with CD Rates

Here’s a list of popular certificates of deposit available at some well known online banks. I thought to list them here to give you some idea of how CD rates are doing at this time.

Online Bank CD
APY Rate
Required Minimum
Ally Bank Classic CD .39% to 1.79% $0
Ally Bank Raise Your Rate CD 1.18% $0
Ally Bank No Penalty CD .91% $0
Sallie Mae CD 1.30% to 2.45% $0
EverBank Yield Pledge CD 0.51% to 1.81% $1,500
EverBank World Currency Single CD Review site for details. $10,000
EverBank World Currency Index CD Review site for details. $20,000
HSBC Advance Online CD .10% to 1.70% $10
ETrade Fixed Rate CD .10% to 1.40% $1,000

Note that EverBank’s World Currency CDs have foreign exposure and have their own risk factors.

Tip: For more information, you can check this article on the best CD rates to see what bank CDs can give you today.

Certificate of Deposit Basics: Facts And Tips On Bank CDs

Now as bank and financial products go, nothing is ever so simple; scratch the surface a little and you’ll find stuff beyond the basics about the asset you own. So how well do you really know bank CDs? Well, here are a few facts that I learned from the Wikipedia and other readings:

  1. Investing a larger sum in a CD doesn’t always mean you’ll get a higher interest rate.
  2. Investing in a CD with a longer term also doesn’t mean you’ll get a better savings account rate. During those rare times when the “yield curve” is inverted, you’ll get lower yields from longer term debt instruments than from those with shorter maturities. It can happen when investors anticipate a recession or economic slump in the future, along with possible lower inflation rates.
  3. Online bank accounts typically offer more attractive rates than their brick and mortar counterparts.
  4. Financial institutions that don’t have FDIC insurance usually offer products with higher yields.
  5. Business certificates of deposit have lower yields than personal accounts.
  6. Larger banks, credit unions and thrifts often offer lower yields than their smaller counterparts.
  7. As an option, some CDs allow you to receive interest as soon as it’s earned, instead of having the interest compound in your CD account. If you take this option, you’ll get a lower yield. If you go this route, you can have the interest funneled into a separate savings account or sent to you via check if you so wish.
  8. Redeeming your CD before it matures will cost you extra (and it can be a lot!) via a withdrawal penalty. Pulling out your money before it fully bakes can cost you several months’ worth of interest, so make sure that the money you put in a time deposit is worth leaving alone for a while!
  9. Certain certificates of deposit are callable; the bank can decide to pull the plug on such a CD prior to its maturity date.
  10. When do CDs start earning interest? Some may start accruing interest on the date you make your deposit while others may start generating interest at a later date (say the following month or several months down the road).
  11. Your bank has the right to hold on to your CD account (or any bank account you own) and prevent you from withdrawing your funds to prevent a bank run.
  12. Be aware of the renewing policies for your CDs because it’s possible for a bank to roll over your CD at very low rates without letting you know first!
certificate of deposit, cd

Techniques To Make The Most Of Your Bank CD

The thing about CDs is that yes, they’re a pretty boring cash investment. But I think you can make them a bit more exciting when you use them as part of a bigger strategy (well, okay just a tad bit more exciting perhaps). Here are some techniques and ideas that I’ve tried with bank CDs:

CD Laddering. I like bank CDs because these investments are guaranteed and I can’t possibly lose my principal this way. But the downside? They are not a very liquid investment — there’s the tradeoff of putting all your money in a long term CD in order to fetch higher yields, so you’re facing an opportunity cost here with your money locked up in a time deposit. What if other investment opportunities present themselves while your money is out of reach?

To address this issue, we can always perform what is called CD laddering. It’s a strategy that allows you to spread your money across CDs with various rates and terms (or maturity dates). These CDs don’t all mature at the same time and each one gives you a different yield over time. Then when each one matures, you have the option of redeeming your money (principal plus accrued interest) or rolling over the proceeds into a new CD with a longer term. This way, you can balance the twin goals of optimizing the rate of return as well as the level of liquidity of your cash investment. Here’s more on CD ladder basics.

Taking The Early Withdrawal Penalty. Just because there is an early withdrawal penalty doesn’t mean you should never touch your bank CD until it matures. Many of us are scared into keeping our money locked up because of this penalty. But I say: weigh your options at all times! If you’ve got a very good case for taking out your money from a CD even if it means having to incur the penalty, then do it.

For instance, if a once in a lifetime investment opportunity comes along, would you use your CD money to fund it? Or if an emergency catches you unprepared, it may still be better to use the funds in your CD account than to go into debt to address it, even if you lose some points in interest. Of course, you’d have to make sure that taking the penalty is the more financially beneficial option to take.

Diversifying With CDs. Finally, think of using CDs as part of the bigger picture. Always aim for a diversified financial portfolio where you hold positions representing all the different asset classes. For your cash position, bank CDs can fit the bill along with high interest savings accounts or money market funds.

Copyright © 2009 The Digerati Life. All Rights Reserved.

{ 16 comments… read them below or add one }

Debbie M August 16, 2009 at 10:01 am

Sometimes the difference in interest rates between savings and CDs is so large that it’s worth buying a CD with money you think you might need to spend before the end of the period. Sometimes, for example, if you could keep a one-year CD for at least six months, you’ll be better off than with savings. This isn’t so true anymore now that there are online savings accounts.

Another weird thing: Any penalties you have to pay on your CD can be deducted from your income for US federal income tax purposes. (I think you have to itemize.)

Craig August 17, 2009 at 12:56 pm

I had a 6 month CD once, but really not sure about doing one again. The rates now are terrible, same as my money market account. I don’t know the advantage to CD’s right now.

Scott Lovingood @ Small Business Coach August 18, 2009 at 10:58 am

The advantages of CDs are the safety of them and generally a slightly higher interest rate. My parents continue to keep nearly all their money in CDs even with the small interest rates they get.

They mainly do it because they are safe and know their money will be there. They also don’t pay a penalty if they take it out early so no downside for them.

I am not sure I would suggest CDs for anything other than very short term where you need the money guaranteed and even then other options should be considered.

Julio August 18, 2009 at 10:58 am

I think you also have to factor in the interest compounding. I’ve seen longer term CD’s compound monthly or credited annually, which makes them less attractive compared to some online savings accounts or reward checking accounts.

Liz N. August 19, 2009 at 9:30 am

Besides the *sometimes* higher interest rates, I like to put some of my money (that would have been in my regular savings account) in CD’s because the penalties for early withdrawals are an added incentive for me to keep my hands off that money.

AnnJo August 19, 2009 at 10:38 am

This may be a quibble, but I think saying that you “can’t possibly” lose your principal with FDIC insured accounts is overstating it. The FDIC is a federal insurance program and is therefore subject to the vagaries of the political system. It aims to have funded reserves of 1.25% of insured deposits (currently, it is not meeting that goal), meaning that 98.75% of insured deposits have nothing backing them up but a promise by Congress. Trust it as much as you trust Congress, and remember they are also promising to pay Social Security and Medicare, AND guarantee against home mortgage loan defaults, underfunded pension defaults, money market failures, and soon, everyone’s health care needs. The current unfunded promises of the federal government are many times our current national GDP and growing.

A flat refusal to honor FDIC insurance claims may not happen, but delays – possibly very long delays – in getting your money back, “means-testing” of claimants, and other political chicanery is entirely likely in the event of major bank failures. Governments can and do go bankrupt. Ours is less likely to than most, but you can’t spend more than you take in forever, as we are now doing, and even the power to tax has its limits.

When it comes to money, the safest mindset is that absolutely nothing should be considered a sure thing, which is why that “don’t keep all your eggs in one basket” saying is probably rule #1 of personal finance.

Also keep in mind that any bank you owe money to can seize your accounts if you become delinquent. I would not buy CDs from a bank I owed money to on a mortgage, HELOC, car loan, business loan, or high balance credit card. (Of course, with today’s CD rates, you’d probably do much better to pay off the loan with the money than put it in a CD.)

Chris August 25, 2009 at 8:58 pm

Just to be sure, you described non-negotiable certificate of deposits sold directly from the bank. Your local broker can also sell you negotiable certificate of deposits in increments of $1,000, that, while being priced at market (they act like bonds), they can be sold before maturity. Many larger banks use this as a funding mechanism. You can also buy brokered Jumbo’s as well but never felt the need. You can also look at CDARS, that essentially breaks up your deposit amongst 2700 or so different banks. This is especially useful for large deposits that would exceed the FDIC ceiling.

CM Duncan September 1, 2009 at 11:37 am

I had left a comment, but typed the email address incorrectly. Those darn long addresses. :O)

Anyway, a commentator had made mention of the FDIC not paying. This is extremely unlikely. But if that time comes, non of your investments will be safe except what you hold in your hand. They have the ability to borrow the necessary funds from the treasury if the fund is depleted. The FDIC does have the ability to borrow if the losses become more than the current fund has. They also recently added an extra assessment that all banks had to pay and will be likely doing another one. In addition, banks that utilize brokered deposits are paying an extra assessment. Banks that use brokered deposits are paying additional assessments depending on their capitalization and mix of core vs. brokered.

You had made mention in your post about CDs may end up being callable. A little known bit of information is that savings and loan institutions can call CDs that have a term of 1-year of greater. The problem is many of them have changed their name so that the depositors really have no idea that the bank is an S&L. Community Commerce Bank in CA is one such bank (S&L).

Jack October 18, 2009 at 8:12 pm

My elderly aunt recently died. Her heirs, myself included, suspect we are missing some of her bank records. How do we search for her POD (Totten Trust) CDs at the various local banks that she might have opened accounts at because of their potentially convenient locations nearby her residence? How do we make a formal inquiry to each of these banks to search their records to determine if she had any accounts at each and if they have any POD CDs that are payable to any of her designated beneficiaries or to the proportionate probate heirs listed in her “Last Will and Testament”, i.e. if there were accounts or CDs without a designated POD beneficiary? Also, is there a standard formal form for making this or these (POD and non-POD accounts information) inquiries that can be used at the multiple banks to simplify the process and save time? Thank your for your help with this.

PS – Additional question: Is there a Federal Reserve Bank department or other Federal Agency that has established a national clearing house that possesses a national database for even broader geographical scope searches of this nature?

Silicon Valley Blogger October 18, 2009 at 9:29 pm

If you know where your aunt’s banks are, then do make an inquiry with each of them and discuss your situation (showing them your aunt’s death certificate would help). I believe that bankers are usually pretty helpful once you tell them about your case.

If you don’t know where to start, why don’t you check out this article on how to find missing money? It provides some resources for trying to track down your “lost” money.

I hope this helps!

If anyone else has ideas, hope you can share them with us.

Ryan December 31, 2009 at 6:42 am

If the owner of a CD dies before the CD matures, can the estate liquidate the CDs without penalty?

stephaniesearight June 13, 2010 at 5:54 pm

What if someone left a cd in your name and they passed away, will you still be able to cash the cd in (redeem it), or does the other person on the account have the say so — as to whether you can have it or not? Not quite sure if I own this asset in this case.

William Tingle Real Estate January 17, 2011 at 9:43 am

CD’s or time deposits are for those who have extra cash lying around and are fearful of the increased risk of many other investment opportunities. Get a time deposit to be more secure but if you want a larger return risks can’t be avoided. Invest in real estate, why not?

mary baugh June 5, 2011 at 2:38 pm

If the bank pays the interest on a CD, where does the money the bank pays come from? Does it take the money you pay for your CD and lend it at higher rate than what they are paying you?

CHERRYBENSON June 7, 2011 at 9:22 am

I am requesting for banks that can give me better access to CDs.

Carol June 18, 2012 at 12:04 pm

Hi,I’m glad I found this site. We have tried to find out information for the last 5 years. Regarding CDs: I have 2 CDs from 1976 and I have contacted the bank and the treasurer who both tell me the records only go back 7 years in the computers. How am I to collect my money from them. The bank itself has changed hands over 13 times. I have the actual CD and have taken them to the bank.

Thank you

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