What Is a CD Account and Is It Right for Me?
June 4, 2020
We all know we should save money, but we’re not often taught how. There are many different types of savings accounts to serve all different types of financial situations.
Today, we’re going to focus on certificate of deposit (CD) accounts and help you figure out if they’re the right choice for you.
You’ll learn all about their rates, rules, and who they’re best for.
What is a CD Account?
A CD account is a less flexible savings account that usually comes with a higher interest rate at the cost of locking funds for a period of one to five years.
The longer you agree to leave your money in the account, the more interest you earn. If you do withdraw money, you pay a penalty.
This may seem like a lot, but here are a few terms you need to understand when it comes to interest rates. Interest is payback you earn on your money when you keep it in an account.
- Fixed Interest Rate: Payback you earn on your money that stays the same for a certain period of time.
- Variable Interest Rate: An interest rate that changes over time, so it could get lower. Most normal savings accounts use this type of interest.
- Annual Percentage Yield (APY): How much money you make by keeping your money in this account for one year.
- Term: This is the length of time you agree to leave your money in an account.
- Principal: This is the amount you agree to deposit when you open the CD.
Most savings accounts have an interest rate that changes over time. This means the amount you earn on your money may go up or down while you have the money in the account.
When it comes to CD accounts, most of the time they offer a fixed rate which stays the same the entire time your money is in the account, until the term ends.
The most important thing to understand about interest rates is the higher they are, the more money you make over time.
Access to your Money
This is where CD accounts can get complicated. Here are a few more important terms to know:
- Maturity: When your term is up and you can withdraw the money without a penalty.
- Early Withdrawal Penalty (EWP): The amount you pay if you take out money before the account matures.
- Default Action: What happens when the CD matures if you do nothing.
- Rollover: When your money is placed in a new CD with the same length, or term, as the original CD after it matures.
But what happens with the term ends and the CD matures? That depends on the agreement with your bank.
When your account matures, you will usually need to withdraw your money or transfer it into a different account. If you don’t after a certain amount of time, your bank will usually roll over your money into a new CD with the same term. But since the CD account is technically a new one, the interest rate could be different than the original one.
Set reminders for your CD maturity date, so you don’t accidentally get locked into a rollover.
Is a CD account Right for You?
So is a CD account right for you? It depends. This type of account can help you save money for specific events, or even just avoid the temptation to spend money rather than saving it.
CD accounts are not a good choice for emergency savings.
The first step is having all the information you need to make a good decision.