Certificates of Deposit, or CDs, allow you to invest your money in a deposit for a specific amount of time, called term, usually at a fixed interest rate. CDs are a good alternative to savings accounts as they usually provide higher interest rates.
There are several types of CDs you can choose from. It’s important to gather all the information before buying a CD as they can have different advantages and disadvantages.
Here is what you need to know about each type of CD.
This is the classic certificate of deposit that allows you to deposit a certain sum and earn a fixed interest rate. At the end of the term, that you can choose when buying your CD, you can cash out or roll over the CD for another term.
This type of CD usually comes with high penalties for early withdrawal so make sure to ask them in advance, On the other hand, this is among the types of CDs with higher interest rates.
Some banks may also offer high-yield CDs to compete with other institutions. These CDs behave like traditional CDs but have higher rates. High-yield CDs are common on online banks.
A liquid CD, also called no-penalty CD, is more flexible as it allows withdrawal before the end of the term without a penalty. You will however pay for the flexibility with lower interest rates than on a traditional CD.
You will still need to wait a certain amount of time before being able to withdraw without a penalty, so make sure to check with the financial institution how long that is.
If the interest rates rise after you buy your CD, bump-up CDs give you the possibility of requesting a higher interest rate, also called a bump-up. However, you have limited bump-ups available within the term, oftentimes just one. You will also need to inform the bank in advance of your wish to request the increase.
A step-up CD is similar to the bump-up CD when it comes to the flexible interest rate, with the difference that the institution will raise it automatically without you having to request it.
Like bump-up CDs, this type starts with a lower interest rate and while it may grow over time you may still end up earning less interest than on a traditional CD.
These CDs are sold through brokerage firms, meaning that you need to have a brokerage account. A brokered CD allows you to benefit from a variety of offerings from different banks with just one account. You may get higher rates with a brokered CD but they are riskier and not always insured through the Federal Deposit Insurance Corp.
Jumbo CDs are similar to traditional ones with the exception that they require a higher deposit. They sometimes have higher interest rates than traditional CDs. However, the deposit usually is of minimum 100.000$ so you need to be sure you will not need that money for the duration of the term.
A zero-coupon CD allows you to buy a CD at a big discount to its par value, meaning the value at maturity. These types of CDs are usually long term and you don’t earn any money until the end of the term or maturity. They are a good option provided that you don’t need to withdraw before maturity. Also, you will have to pay taxes on the earnings being accrued even if you will have virtually no money entering your pockets.
Callable CDs are risky options as they may allow you to earn high interest but if the rates fall, your financial institution can “call back” the CD before the end of the term and allow you to receive the money you invested and the interest earned so far only to reinvest it at a lower rate.
While most CDs only allow you to make the initial opening deposit, add-on CDs allow you to make additional deposits throughout the term of your CD. However, there is usually a limited number of deposits you can make so make sure to check in advance.
Foreign currency CD
The last type of CD can be quite risky as it is issued in other currencies and the interest you earn is based on the fluctuation of global economic conditions. You buy the CD with US dollars that will be converted to another currency like euros or British pounds and converted back to US dollars at the end of the term. Your earnings will also vary depending on the value of the dollar at the end of the term when the amount gets converted back. You can end up earning a lot more but also losing.