How to Choose a CD, and When Locking Up Cash Makes Sense

The FDIC sets its standard coverage limit at 250,000 dollars per depositor, per FDIC-insured bank, per ownership category. That rule covers CDs too. Everything else about a CD, from the rate to the penalty to what happens at maturity, is set by the bank and written into the account terms, which is why two CDs with the same headline rate can turn out very differently for someone who needs the money back early.

A CD is a deposit with a fixed rate and a fixed term. You deposit the money and the bank promises a rate for a set period. At the end you get it back with interest. Take it out early and you pay a penalty.

Rates change too often to quote, so every figure below is hypothetical.

When locking cash up makes sense

A trading reserve needs to be reachable, and a CD is the opposite. So the real question is which slice of your cash you are confident you will not touch for the whole term, even after a sharp drop hands you the kind of buying opportunity a trader hates to miss.

Money for a known bill on a known date fits. So does part of a large reserve you would never deploy all at once. For money you might need on short notice, a high-yield savings account does the job with a variable rate.

A fixed rate cuts both ways. If rates fall, you keep the higher one. If they rise, you are stuck with the lower one until maturity, and whether either outcome leaves you ahead of prices depends on inflation, which is the subject of real interest rates.

What to compare

APY at the same term. Compare 6-month CDs with 6-month CDs. APY includes compounding. That makes it the right number whatever schedule the bank credits interest on.

Compounding and payout. Some CDs add interest to the balance. Others pay it out to another account. Paid-out interest does not compound.

Minimum deposit. Some rates apply only above a stated amount.

Maturity terms. Check the grace period, whether the CD renews by default, and what rate a renewal would get, because an automatic rollover at whatever rate the bank then offers can lock your money up again for a full term you never actively chose.

The early withdrawal penalty

CDs differ most here. Penalties are usually stated as a number of months of interest, they vary by term and by bank, and at some banks the penalty can come out of principal when you have not yet earned enough interest to cover it.

The same penalty after ten months takes 100 of roughly 333 in interest. Read the penalty clause before you compare rates at all.

Callable CDs

A callable CD lets the bank end it early, on set dates. Banks tend to call when rates have dropped, which is exactly when you would want to keep the old rate, and although callable CDs tend to pay more than comparable non-callable ones to make up for that, the extra only helps if the CD survives long enough to pay it. Check the call dates. Treat the stated term as the longest you might hold it.

Brokered CDs

You can also buy CDs through a brokerage account. Banks issue them. The broker sells them. They behave differently from bank CDs in one important way.

There is usually no early withdrawal. If you need the money, you sell the CD on a secondary market, and the price depends on rates at that moment, so a CD bought when rates were lower will sell below its face value once rates have risen, because a buyer can get a new CD paying more. Held to maturity, it pays face value plus interest.

They are still FDIC-insured at the issuing bank within the limits. The broker’s records have to show you as the owner.

That creates a trap. If you already have deposits at the issuing bank, the brokered CD shares a single 250,000 dollar limit with those deposits when the ownership category matches, so a trader who buys one without checking the issuer can end up over the limit at a bank they already use.

Look up the issuing bank in FDIC BankFind. For the brokerage itself, see how to choose an online broker.

Building a ladder

A ladder splits your money across several maturities. Part of it comes free at regular intervals.

After the first year you earn a 12-month rate on all of it, and you are never more than three months away from having a quarter of the money back in hand, which suits a reserve you want mostly working and partly available. If you might need everything at once, a ladder will not help. That money belongs in savings.

Red flags

• A penalty clause you cannot find before you deposit.
• A callable CD sold without the call dates shown up front.
• A renewal notice that leaves out the new rate or the length of the grace period.
• An issuer that does not appear in BankFind.