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, and CDs fall under that rule like any other deposit. The rest is up to the bank. The rate, the penalty and what happens at maturity all sit in the account terms, which is why two CDs with the same headline rate can end very differently for someone who needs the money back early.

A CD is a deposit with a fixed rate and a fixed term. You hand over the money, the bank promises a rate for a set period, and 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 has to be reachable, and a CD is built to be the opposite. So the question is which slice of your cash you’re confident you won’t 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’d 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’re stuck with the lower one until maturity, and whether either outcome leaves you ahead of prices comes down to inflation, which is what real interest rates are about.

What to compare

Start with APY, and compare it at the same term: 6-month CDs against 6-month CDs. APY includes compounding, so it’s the right number whatever schedule the bank uses to credit interest.

Then look at where the interest goes. Some CDs add it to the balance. Others pay it out to another account, and interest that’s been paid out doesn’t compound.

Watch the minimum deposit, too. Some rates apply only above a stated amount.

Last come the 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

This is where CDs differ most. 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 haven’t 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’d want to keep the old rate. Callable CDs tend to pay more than comparable non-callable ones to make up for that, although the extra only helps if the CD survives long enough to pay it, so check the call dates and treat the stated term as the longest you might hold it.

Brokered CDs

You can also buy CDs through a brokerage account. A bank still issues them. The broker sells them, and the big difference from a bank CD shows up when you want out.

There’s 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. Hold it to maturity and it pays face value plus interest.

It’s still FDIC-insured at the issuing bank within the limits, as long as the broker’s records show you as the owner.

Watch for overlap. 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 choosing the brokerage itself, see how to choose an online broker.

Building a ladder

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

After the first year you earn a 12-month rate on all of it, and you’re 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. A ladder won’t help if you might need everything at once. Keep that money in savings.

Red flags

• A penalty clause you can’t 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 how long the grace period is.
• An issuer that doesn’t show up in BankFind.