Certificates of Deposit

There are many types of certificates of deposit (CD’s), but all share a common characteristic: the money deposited must remain in the account for a specified time, with severe penalties for early withdrawal. On most CD’s the interest remains the same throughout the life of the certificate. By and large, the longer the life of the certificate the higher the interest rate, except, in some cases, very long term certificates. At one time, stringent regulations governed CD’s in denominations less than $100,000, making them somewhat unattractive investments. In recent years, these regulations have been eased, and the purchase of lower priced CD’s has become a desirable investment for many people.

The main advantage of fixed-interest CD’s is that the interest rate is guaranteed for the life of the certificate, whether or not prevailing rates of interest fall. This, of course, can become a disadvantage if general interest rates rise.

The primary drawback of a CD is that your money is tied up for a specified period. If you decide to withdraw your funds from a CD before its maturity, you must first get the bank’s approval and then be prepared to pay a significant penalty. Under current federal rules, early withdrawal penalties for CD’s issued after October 1, 1983 amount to three months’ loss of interest for certificates maturing in more than a year, and 31 days loss of interest for certificates that mature in less than a year. (Penalties are not exacted if a CD is redeemed early because the owner has died or has been declared legally incompetent.)

A CD owner who is pressed for cash may have an alternative to early redemption. Many banks will accept CD’s as collateral for a loan. The rate charged on such a loan, however, may be so high that it is more economical to cash in the CD and accept the penalty. In other instances, it may be worthwhile to take out a loan to avoid the penalty. The determining factor is the length of time for which the loan is needed.

Read about Fluctuating-Rate CD’s and CD Reinvesting in the following posts.