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What Is a Certificate of Deposit?

November 13, 2020 · 7 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

What Is a Certificate of Deposit?

Saving money is an important part of just about everyone’s road to financial wellness. Stowed-away cash comes in especially handy when it’s time to make a down payment on a home or clock in for the very last time.

Of course, there are plenty of ways to stash said cash, ranging from stuffing it under a mattress (which, spoiler alert, is probably not the best move) to investing it in the stock market.

Each savings option has its own risks and benefits, and it’s important to understand them in-depth before making big decisions.

In this article, we’re going to highlight one of the unsung heroes of the money-saving game: certificates of deposit, or CDs. These unique savings vehicles offer customers a balance between growth opportunity and risk management.

Is a Certificate of Deposit Just a Savings Account?

A certificate of deposit has some similarities to a savings account. It’s a financial product built to help consumers save their money and help it grow over time.

However, unlike a savings account, CD holders aren’t able to access the funds in their certificate of deposit whenever they feel like it—at least not without paying an early withdrawal penalty, in most cases.

In exchange for giving up the ability to freely withdraw the money in a CD, the institution rewards CD holders with higher interest rates than they’d see in a typical savings account.

However, the funds are still FDIC-insured to the maximum legal limit of $250,000, making a certificate of deposit a relatively risk-free way to invest and grow your money.

Let’s take a closer look at exactly how this all works.

How Does a Certificate of Deposit Work?

When a customer goes to open a CD they’ll be asked to put down a lump sum, usually with a fairly high minimum deposit amount—perhaps $1,000 or $5,000.

The amount of money placed in a CD is also called its principal, because it is essentially a loan the consumer is offering to the bank. The interest the customer collects is what the bank pays for the privilege of borrowing the money.

Certificates of deposit also carry a “term,” much like a loan does; the term is the amount of time the funds must be left in the CD in order to glean the advertised interest rate.

The term might be as short as a few months or as long as a decade, and generally, longer terms carry higher interest rates. The day the term is over is also known as the CD’s maturity date. A longer-term CD may not necessarily require a higher minimum deposit or principal.

Long story short: When opening a CD, a customer deposits a set amount of money for a set amount of time and agrees to leave it untouched in return for a relatively high fixed interest rate they’ll earn on the principal once the term comes to an end.

But how high, exactly, are the interest rates we’re talking about?

Certificate of Deposit Rates

Certificates of deposit are attractive savings options because they usually offer higher rates than the savings accounts, but are also a lower-risk option than, for example, investing in the stock market.

Since funds in CDs are FDIC-insured, account holders can rest with some assurance that their cash won’t simply disappear (as it may do when invested in shares of a company).

At the time of this writing, the national average rate for a normal savings account is 0.08% APY, whereas the national average rate for a 12-month CD is 0.37% APY. The national average rate for a 60-month CD jumps to 0.7% APY.

But it’s possible to find CDs with even higher rates than that by shopping around.

Certificate of Deposits: Fine Print

There are a few more things it’s important to know about CDs before deciding to open one.

Generally, CDs automatically renew once the term is up if the account holder doesn’t take the money out. Generally, the bank will roll the CD over into a new CD with the same term. (For example, a one-year CD whose funds aren’t collected on the maturity date would be rolled over into a new one-year CD.)

Most financial institutions offer CD holders a grace period, or a fixed amount of days after the maturity date, during which the account holder can decide whether to withdraw the funds, transfer them to a new account or CD, or allow them to roll over.

Finally, but importantly, most CDs are generally subject to an early withdrawal penalty, which is incurred if the money is accessed prior to the maturity date.

Early withdrawal penalties are determined by each financial institution. Depending on the policy, account holders could lose out on interest, or even lose some of their principal deposit.

Certificates of Deposit: Pros and Cons

As our discussion thus far shows, CDs can play an important role in an overall savings strategy because they balance growth and risk management.

But as does any financial product, CDs have both drawbacks and benefits, which should be considered carefully before opening one.

Pros of CDs

•  Because CDs are FDIC-insured, they’re a relatively low risk account. The FDIC insures up to $250,000, which means if an FDIC-insured institution goes out of business, account holders with a CD would receive their principal and interest, up to $250,000. With riskier options, like investing in stocks, returns and contributions aren’t insured.
•  Higher interest rates are available for CDs than for similar savings vehicles, like savings accounts, making it easier to see a higher return on investment.

Cons of CDs

•  Although CDs carry higher interest rates than some other types of savings vehicles—a few of which we’ll cover in more depth in just a minute—they don’t have the same kind of exponential earning potential that stock market investments do.
•  CD holders generally don’t have the ability to withdraw their money at any time, at least without being subject to a penalty. That makes a certificate of deposit a poor choice for certain savings goals, like an emergency fund, which should be readily available.

Where to Open a Certificate of Deposit

Certificates of deposit are available from a wide variety of financial institutions, including both national banks, credit unions, and online-only financial institutions.

Shopping around can help ensure consumers find the best rates and most favorable terms for their needs.

That said, there are also some alternatives to opening a certificate of deposit that are worth considering carefully.

Alternatives to the Certificate of Deposit

Although CDs are a great way to earn interest, they’re far from the only high-interest account option out there. Here are a few options to mull over.

High-Yield Checking and Savings Accounts

Although typical savings accounts offer a relatively low interest rate, high-yield checking and savings accounts are available from some banks.

This option helps consumers combine growth potential with the ability to access their money as they need it, and can be a good alternative to CDs for those who aren’t ready to lock away their money for a year or more.

Certain high-yield accounts may offer up to high APY. However, there may be fine print involved requiring certain behaviors or actions in order to maintain that rate, such as making a minimum number of transactions per month or maintaining a minimum account balance.

Always be sure to review paperwork carefully before opening any kind of financial account.

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Money Market Deposit Accounts

Money market deposit accounts are another option which, similarly to CDs, tend to offer higher interest rates than your typical savings account does.

And unlike CDs, money market deposit account holders are generally allowed to write checks or process debit transactions against their funds, which are still covered by FDIC insurance.

While money market deposit accounts can earn higher interest rates than traditional savings accounts, there are monthly restrictions on the number of deposits and withdrawals.

Money market deposit accounts might require a high minimum balance in order to avoid monthly fees.

Stock Market Investments

Finally, for consumers focused on growing their money in the long-term, investing in the stock market can provide a lot of potential for growth.

The power of compound interest means that stock market investors can see appreciable growth, especially over long periods of time.

Historically, the S&P 500—an index tracking 500 of the largest corporations exchanged on the NYSE or NASDAQ—has seen an average annual return of 8% .

Of course, an investment account is very different from a savings account or CD in that there is no FDIC insurance on the funds.

Investments in the stock market are vulnerable to market fluctuation, and there’s no guarantee that investments will be safe and make money.

It is important to remember that investments have no guarantee and are subject to potential losses.

That said, many financial professionals and advisors still recommend long-term investing as one of the best ways to grow wealth over time and as a part of an overall plan for long-term financial goals like retirement.

Alternative Account Options

CDs, money market deposit accounts, and even plain-old checking and savings accounts can all be important parts of a sound financial strategy. CDs in particular can be good vehicles to help augment savings for shorter-term financial goals.

For those looking for an alternative option, SoFi Checking and Savings may be a good option to look into. SoFi Checking and Savings® is a high interest bank account where you can spend and save with no account fees (subject to change).

Plus, you’ll earn cash back rewards on spending with recurring $500 monthly deposits.

Learn more about how SoFi Checking and Savings might help you reach your financial goals.

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SoFi members with direct deposit can earn up to 3.75% annual percentage yield (APY) interest on Savings account balances (including Vaults) and up to 2.50% APY on Checking account balances. There is no minimum direct deposit amount required to qualify for these rates. Members without direct deposit will earn 1.20% APY on all account balances in Checking and Savings (including Vaults). Interest rates are variable and subject to change at any time. These rates are current as of 12/16/2022. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet


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