Considering a CD

Shopping at your credit union for a CD (certificate of deposit) isn’t quite as easy as going to the local music store for a CD (compact disc). But it’s a lot easier to choose than some other types of investments.

By definition, a CD or certificate of deposit is a time deposit. That means you deposit money into an account with your credit union or bank and agree to keep it there for a specific number of days. In exchange, you are guaranteed a predetermined interest rate and yield on your money. The most common CD accounts are opened for six, 12, 24, 36, 48 or 60 months.

There are two basic types of CDs, regular CDs and Individual Retirement Account (IRA) CDs. IRAs typically pay the same interest rate as regular CDs. However, IRAs offer additional federal insurance allowing investors to hold an IRA account up to $250,000. Additionally, the interest earned on IRA CDs isn’t taxed until you retire or reach the age of 59.5 years. This taxation relief is perfect for individuals who have determined that their CDs will be used for retirement only, rather than short-term, quick-return investments. However, it’s important to note that for an IRA to remain tax-free certain guidelines must be followed.

While CD interest rates are ever changing, those changes are a reflection of the economic health of the country. When general loan rates are high, CD rates will increase and vice versa. The length of time you commit to when you select a CD also affects your rate. Usually, the longer the term is, the higher the interest rate will be.

There are other factors which figure into the equation, and those factors aren’t always so predictable. For instance, competition between financial institutions can make a difference. Among the factors that can affect CD rates are consumer pricing and spending, where you live, and even how your financial institution is doing internally. “Comparison shopping” is the key.

Credit unions typically offer better rates than banks because credit unions are non-profit organizations focused on serving their members rather than paying stockholders. Also credit unions usually have lower overhead costs and pay a bit higher on CDs than at banks. It pays to take the time to monitor the market in your area for a couple of weeks and see who has the best rate for you.

Should you pick a short-term or long-term CD? To answer that you’ll need to determine how long you can let go of your money. Do you have any big purchases around the corner like a new car or a new home? Most CDs have penalties for early withdrawal which will cost you money. If you may need the money in six months or a year, pick a CD that will come up for renewal when you think you’ll need your money. If that’s not a problem, a longer-term CD may offer a better rate.

Knowing when to buy requires daily tracking of CD rates over two or three weeks. If they stay steady, go for the best deal offered and look to long term. Steady rates indicate a steady economy and show no sign of rapidly increasing rates. If they are rising slowly and suddenly take a half percentage point upwards—hold off a bit longer. This could indicate that interest rates haven’t peaked yet. In this situation wait until rates start to climb a bit slower or taper off completely. Gauge the market on your own observations; don’t make your decisions just on what specials are being advertised. If a bank recognizes that CD rates are going to increase, it is in their best interest to push long-term CDs while the rates are lower. Don’t be too hard on yourself if your timing isn’t perfect; even the professionals don’t hit it right every time.

When you’re ready to buy, the authors of The Complete Idiot’s Guide to Managing Your Money suggest you ask the following questions:

  • What are the rate and yield, and how is the interest compounded? “Rate” refers to the amount of interest added to your original amount. “Yield” is the amount paid to your account after the interest is included. “Compounded” refers to the interest that’s added to interest; the more often an account is compounded the better.
  • Is the rate fixed or variable? How long is the rate effective?
  • What is the minimum deposit necessary to open the account?
  • Can you add to the account later on—and if so, at what rate? Do the added rates mature at the same time as your original deposit?
  • How much will you receive in interest—in actual dollars and cents—when the account matures?
  • What is the penalty if you withdraw any of the funds before the account matures?
  • To avoid rolling a mature certificate of deposit over at the new interest rate, when and how do you handle the withdrawing of your money?
  • What other benefits do you receive as a CD customer? Will they waive any fees or charges on checking accounts, ATM transactions, or annual fees on credit cards?
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