certificate of deposit

Banking Terms -> certificate of deposit

• The term certificate of deposit refers to a promissory note, which is issued by a banking establishment. With time deposits like this, withdrawals are possible but often result in a penalty. This means that withdrawing funds is restricted. Certificates of deposit entitle bearers to receive interest at a set interest rate. They have a term or maturity and can be issued in various denominations. The term of CDs spans from 1 month to 5 years, and they are typically issued by commercial banks. In some cases, certificates of deposits are indexed to the bond market or stock market, and other indices may be introduced as well.
  
  Investors are paid interest in exchange for loaning funds to an institution for a specified period. The interest increases in proportion to the period over which funds are loaned out. Certificates of deposit come with one major advantage. Investors can calculate the amount of expected earnings when they make the investment. Given that CDs are FDIC-insured, they are a good option for elderly people who want to maintain some capital over the course of their life. On the other hand, when investors choose a higher interest rate and longer maturity, they forgo other, sometimes more profitable uses of their capital.
  
  In general, CDs are mid-term to long-term investment instruments offered by banking and savings and loan institutions. Banks offer higher interest rates in order to use investors’ money for a longer period of time. Why cannot banks let customers use this money anytime they need them? Banks also make various commitments with the funds. They lend them to other clients and trade investment securities. If you decide to withdraw your money on demand, the bank may be forced to pay a penalty some other place. Banking establishments charge a penalty that is usually in the amount of interest you could have earned by holding the certificate to maturity.
  
  There is no threshold for the amount of the penalty, so it is important to read the terms and conditions. If you hold a relatively short-term certificate of deposit and withdraw your money before maturity, you will pay between 1 and 3 months of interest. This applies to CDs with a term of one year or less. For certificates of deposit with longer terms, you may pay over 3 months of interest. If you hold a 5-year certificate of deposit, you may lose 6 months of interest. In general, the longer the term, the higher the penalty will be. While losing some of the interest may not sound that bad, it may happen that you haven’t earned it yet. In this situation, the bank may take a portion of the principal, and you will be left with less than the amount of your original investment. Unless you have another investment in mind, that will bring you a substantially higher return, it is not a good idea to withdraw the money before maturity. You may withdraw your money at maturity, along with the accrued interest.
  
  It should be noted that a bigger principal generally receives a higher interest, but this is not always the case. In addition, certificates of deposits with longer terms also go with a higher interest rate, but not before recession (when inverted yield curve is observed). If you want to find a better rate, check with smaller institutions first. They are likely to give you a better rate than larger ones. In addition, business CD accounts generally receive lower interest rate compared to personal CD accounts. Finally credit unions and banks, which are not insured by NCUA or FDIC, often offer a higher interest rate.

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