What is a certificate of deposit (CD)?

How a Certificate of Deposit (CD) Works

While a certificate of deposit (CD) is another form of savings account offered by most financial institutions, it operates in a very different fashion from classic accounts or money market accounts (MMAs).

Like MMAs, CDs typically offer higher interest rates than most other savings accounts. CD rates normally are affected by the banalce and length of commitment of the CDs you choose to purchase. Here are the primary differences between a CD and other savings accounts.

• They are purchased for a specific amount of money. Unlike traditional savings accounts that allow you to start your account with almost any amount of money or MMAs that specify a minimum amount, but allow increases at will thereafter, CDs are purchased for a specific amount of money as allowed by your bank or credit union.
• They have a specific maturity date. Savings accounts and MMAs are typically “evergreen” options, as they have no end and theoretically last forever or, at least, until you decide to close the account.
• They usually do not permit any additions to, or withdrawals from, your initial deposit. You should invest only monies that you should not need for the term of the CD and not funds that might be necessary for use.
• You will pay a penalty for any early withdrawals from a CD balance. If an emergency arises and you must have access to some or all monies in a CD, you will pay a penalty, possibly amounting to all the interest you have earned to date.
• A CD is actually a “contract” between you and your financial institution wherein you agree to keep an amount of money with them for an agreed period of time. In return, your bank or credit union agrees to pay you a stated interest rate, usually higher than any other savings account, for the term of the certificate of deposit.

A CD is a very effective way to earn higher interest rates, enjoy the protection of Federal insurance on your balance (up to $100,000), and select a time frame that works for you. CDs typically are offered in time segments of from six months to around five years. You can choose the contract times that fit your financial plans.