How Does a Certificate of Deposit (CD) Work in Banking?

Certificates of Deposit (CDs) are a savings option offered by financial institutions. They are a secure, low-risk investment for individuals aiming to grow savings over a defined period, providing a predictable return.

Core Features of Certificates of Deposit

A Certificate of Deposit is a time deposit account, holding funds for a predetermined term until a fixed maturity date. Financial institutions offer various term lengths, from three months to five years or more. The interest rate is fixed at deposit and remains constant throughout the term, providing a guaranteed return.

CDs have a fixed term, and early withdrawals typically incur a penalty. These penalties are usually a forfeiture of interest, often ranging from several days to several months, depending on the CD’s term and institution policy. For example, penalties might be 90 days of interest for shorter-term CDs or 180 to 365 days for longer terms. If interest earned is less than the penalty, a portion of the principal may be forfeited.

CDs are insured by federal agencies. Deposits at banks are insured by the Federal Deposit Insurance Corporation (FDIC), and deposits at credit unions by the National Credit Union Administration (NCUA). Both insure up to $250,000 per depositor, per institution, per ownership category, protecting principal and accrued interest, and ensuring the safety of funds even if the financial institution were to fail.

Variations of Certificates of Deposit

Beyond the traditional fixed-rate, fixed-term CD, several variations offer different features. The Standard or Traditional CD has a fixed interest rate and set maturity date, providing a predictable return if held until maturity.

Jumbo CDs require a larger minimum deposit (e.g., $100,000+) and may offer slightly higher interest rates. Callable CDs allow the issuing institution to redeem the CD before maturity, typically if interest rates decline. This can impact the investor’s expected return if the CD is called early.

Brokered CDs are offered through brokerage firms, not directly by banks, providing access to a wider range of institutions and terms. They may also have a secondary market, offering some liquidity, though their market value can fluctuate. Step-Up CDs feature an interest rate that increases at predetermined intervals, allowing for potential rate improvements without reinvesting.

Liquid or No-Penalty CDs allow penalty-free withdrawals of principal and earned interest after an initial waiting period, typically seven days. They offer access to funds while earning interest, though often at lower rates than traditional CDs. Bump-Up CDs allow the account holder to request a rate increase if market rates rise during the CD term.

Steps to Open a Certificate of Deposit

Opening a Certificate of Deposit account begins with gathering necessary personal and financial information. Prospective account holders need to provide government-issued identification (e.g., driver’s license or state ID) and their Social Security Number or Taxpayer Identification Number. This information is used for identity verification and tax reporting.

After selecting a financial institution, which can be a bank or a credit union, the application can be completed online, in-person at a branch, or over the phone. The application requires details about the desired CD term and initial deposit amount.

Next, fund the CD by transferring the initial deposit. This can be done through an electronic transfer from an existing checking or savings account, by depositing a check, or via wire transfer. The funding method depends on the institution’s options and your preferences.

Upon successful application and funding, the financial institution will provide confirmation documents. These documents typically include the CD’s terms, the fixed interest rate, the maturity date, and details regarding any early withdrawal penalties. Review these documents carefully to ensure all terms align with expectations and for a clear record.

What Happens at CD Maturity

As a CD approaches its maturity date, financial institutions notify the account holder, typically several weeks prior, outlining options for the funds. The maturity date marks the end of the CD’s term, making the principal and all accrued interest accessible.

At maturity, account holders have three options. One is to roll over or renew the CD for a new term, at the current market interest rate. Many CDs auto-renew, but account holders usually have a grace period (often 7-10 days after maturity) to make a different decision without penalty.

Another option is to withdraw the funds. This can involve transferring the money to another account (at the same or an external institution) or receiving a check. This allows access to funds for other financial goals.

A third option is a partial withdrawal and partial renewal, where some funds are withdrawn and the rest renewed into a new CD. This offers flexibility for those needing liquidity while continuing to earn interest. To avoid automatic renewal or choose a specific action, communicate your decision to the financial institution within the grace period.