by Michael Sanibel

Created on: October 01, 2008   Last Updated: October 07, 2008

Saving with Certificate of Deposit Accounts.

DEFINITION
A Certificate of Deposit (CD) is a promissory note or debt instrument issued by a financial institution entitling the bearer to receive interest. A CD typically bears a specified fixed interest rate, a maturity date, and can be issued in any denomination. Variable rate CDs, including those with step-up or step-down features, are available but are far less common. CDs are generally issued by commercial banks and credit unions and are insured by the FDIC and NCUA up to a maximum account value of $100,000. The term of a CD generally ranges from one month to five years, and cannot be changed once the CD is originated. Most banks provide for automatic renewals or rollovers upon expiration of the maturity period.

HOW IT WORKS
Purchasing a CD is a relatively simple process and can be done in person, through the mail, or online. The "certificate" is usually a confirmation letter which documents the amount, term, interest rate, and maturity date. Unlike a savings account, a CD is issued for a fixed amount that will not change during the term period. In addition, the CD is a time deposit that restricts holders from withdrawing funds on demand. Withdrawal of funds in an active CD will usually incur a substantial financial penalty.

The key choices you make when opening a CD are the total amount invested, term, and corresponding interest rate. The reward for a longer term is typically a higher interest rate. This is because a longer term gives the bank greater flexibility in its ability to loan your money to other customers, or pursue other investments to create even greater returns. CDs that are less than $100,000 are called "small CDs" and those for more than $100,000 are called "large CDs" or "jumbo CDs". Jumbo CDs usually enjoy higher interest rates as a reward for investing large sums with the issuing bank. Almost all large CDs, as well as some small CDs, are negotiable.

When the CD is opened, you will typically be offered the option of having the interest mailed as a check or transferred into a checking or savings account. This reduces the total yield because there is no compounding of interest. Shortly before the CD matures, most institutions will send a notice to the CD holder requesting disposition instructions within a specified time window. This normally offers the choice of withdrawing the principal and accumulated interest with no penalty, or rolling it over into a new CD. If no action is taken by the holder,

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