How a Certificate of Deposit Works at a Bank

Certificates of Deposit (CDs) are a financial product offered by banks, allowing individuals to grow savings. These accounts hold funds for a specific period, earning interest. This guide explores the fundamental aspects of CDs and the process of opening one.

What is a Certificate of Deposit?

A Certificate of Deposit is a type of savings account that holds a fixed amount of money for a fixed period of time, and in return, the bank pays interest. When an individual opens a CD, they deposit a lump sum, known as the principal, into the account. This principal then remains untouched for a predetermined length of time, referred to as the term or maturity period.

During this term, the deposited money earns interest at a fixed rate that is established when the CD is opened. Unlike a regular savings account where the interest rate might change, the rate on a CD remains constant for the entire term. The money is essentially “locked in” until the maturity date, allowing the interest to accrue consistently. At the end of the term, the original principal, along with all the accumulated interest, becomes available to the account holder.

Essential Features of CDs

CDs have several defining characteristics. A primary feature is their fixed interest rate, which means the rate applied to the deposit is set at the time of account opening and does not change throughout the CD’s term. This provides predictability regarding the earnings the deposit will generate over its lifespan.

Early withdrawal from a CD before its maturity date incurs a penalty. This penalty often involves forfeiting a portion of the interest that has been earned, such as a few months of interest for shorter terms or up to a year’s worth of interest for longer terms. In some cases, if the penalty exceeds the earned interest, a portion of the principal might be affected.

Upon maturity, account holders have several options. They can withdraw the principal and earned interest, renew the CD, or roll funds into a different account. CDs offered by banks that are members of the Federal Deposit Insurance Corporation (FDIC) benefit from deposit insurance. This coverage protects deposits up to $250,000 per depositor, per insured bank, for each ownership category, safeguarding funds in the event of a bank failure. This insurance applies to both the principal and any accrued interest within limits.

Opening a CD at a Bank

Preparing to Open a CD

Before initiating the application process for a Certificate of Deposit, gathering specific information and documentation helps streamline the experience. Individuals need to present a government-issued identification, such as a driver’s license or passport, to verify their identity. A Social Security number (SSN) or another tax identification number is also required for tax reporting purposes.

Additionally, proof of address, such as a recent utility bill or bank statement, is often necessary. Having details about the funding source for the initial deposit, like an existing bank account number, is also important. Preparing these items in advance ensures a smoother process when applying for the CD.

The Application Process

Once all necessary information and documents are ready, the actual application for a CD can begin. Most banks offer multiple ways to apply, including in-person at a branch, through an online application portal, or over the phone. During the application, individuals select the desired CD term and the amount of the initial deposit.

The gathered personal and financial information is then provided to the bank. After the application is completed and accepted, the CD is funded with the chosen deposit amount. The bank then provides confirmation of the new CD account, along with the terms and conditions, including the fixed interest rate and maturity date.