What Is a Certificate of Deposit (CD)?

There are many types of CDs, and they all work a little differently.

Traditional CD: A traditional CD is the type outlined above. You place money into the account; your interest rate is locked in for the full CD term; and you pay a penalty if you withdraw the funds before the CD has matured.

Jumbo CD: Jumbo CDs work just like traditional CDs, but they tend to have much higher minimum deposit requirements. You can usually open traditional CDs with $5,000 or less, but jumbo CDs usually require at least $50,000 — some may require $100,000 or more. If you are able to come up with this much cash, you’ll be rewarded with a higher interest rate.

No-penalty CD: No-penalty CDs, also called liquid CDs, are CDs that don’t charge a penalty if you withdraw funds before the CD term is up. Because there are no consequences for withdrawing funds early, these CDs usually don’t have interest rates as high as those of CDs that impose penalties. Look into high-yield savings accounts before investing in a no-penalty CD — if the rates aren’t significantly different, you may prefer a high-yield savings account and its flexibility in accessing your funds.

Bump-up CD: A bump-up CD, also known as a raise-your-rate CD, enables you to request a rate increase at any point during the CD term. It’s a good choice if you’re worried about CD rates rising over the course of your term. You’ll probably be limited in the number of times you can request a rate increase, so you must use them strategically.

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Bump-up CDs might start with a lower interest rate than those of comparable traditional CDs. As a result, though you can raise your rate over the CD term, you might end up earning about the same amount with a bump-up CD as you would have with a traditional CD of the same length.

Step-up CD: Step-up CDs are similar to bump-up CDs, except the bank automatically raises your rate at regular intervals if CD rates have increased since you opened yours. If rates haven’t risen, your CD rate stays the same. You don’t have to worry about your rate decreasing with a step-up CD.

Callable CD: Callable CDs are sort of the opposite of bump-up and step-up CDs. These CDs may have a higher APY to start with, but they carry a big risk. These rates are only locked in for a short time, known as the call protection period. Once this period expires, your bank may “call” the CD away from you at any time and reissue a new CD for the remainder of your term at a lower interest rate.

Banks won’t lower your interest rate just for kicks, but if rates have fallen a lot since you opened your callable CD, there’s a good chance you’ll see your rate drop when the call protection period ends, and earn less in interest overall.

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Zero-coupon CD: A zero-coupon CD is a CD you buy at a discount. For example, you might buy a $50,000 CD for $25,000. You don’t receive periodic interest payments over the CD term like you do with a traditional CD, but when the CD matures, you get the full face value of the CD. You’ll still be responsible for paying taxes on your earnings every year, even if they’re not showing up in your account yet. Zero-coupon CDs also tend to require longer terms, so they’re not a good fit if you only want to invest your money for a few months or a year or two.

Add-on CD: An add-on CD enables you to make additional deposits into the CD after you open it. Traditional CDs only allow a single deposit. If you want to put more money in a CD, you have to open a new one. But an add-on CD lets you to keep all your money together. Your bank might limit the number of additional deposits you can make, so look into the details before you sign up.

IRA CD: An IRA CD can be any of the other types of CDs, but it’s housed inside your IRA. Money in traditional IRAs is usually tax-deferred, so if you keep an IRA CD in one of these accounts, you won’t have to worry about paying taxes on your earnings until you withdraw the money in retirement. But if you withdraw funds before the CD term is up, you could pay your CD’s penalty plus an early withdrawal penalty from your IRA if you’re under 59 1/2.

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Brokered CD: A brokered CD is a CD you buy from a brokerage firm. You can sometimes find better rates with brokered CDs, and you can trade them just like you would other investments — but they also carry greater risk. Not all brokered CDs are FDIC-insured, which means if the bank goes under, you risk losing your money. Plus, if you decide to sell your CD before the maturity date and rates have risen since you purchased it, you might have to take a loss to tempt someone else into buying your lower-earning CD. Brokered CDs can also be callable, which could impact how much you earn in interest.

Foreign currency CD: Foreign currency CDs are based on one or more currencies other than the U.S. dollar. You can make money or lose money, depending on how these currencies fluctuate in value relative to the dollar over the CD term. Once the term ends or you withdraw your money, the CD funds are converted back into U.S. dollars. These CDs are rare, and are not a great investment unless you really understand what you’re getting into.

View more information: https://www.fool.com/the-ascent/banks/what-is-certificate-of-deposit-cd-/

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