You have likely heard of Certificates of Deposit
, or “CDs”, but how much do you actually know about this low-risk investment
option? Did you also know that there are different types of CDs to consider, including “bump-up” and “add-on” versions?
Below, we dive into exactly what a certificate of deposit is, and explore some of the CD variations that might work best for you.
What is a Certificate of Deposit?
A certificate of deposit allows you to earn interest on a lump-sum
of money that you deposit at a bank or credit union, and agree not to withdraw for a specified amount of time. The interest rate earned with a CD is typically higher than that of a traditional savings account
. Basically, the financial institution pays out a higher interest rate to you in exchange for the promise of you keeping your deposit there until the CD term length ends. This is typically referred to as the CD’s “maturity date”. Banks and credit unions typically offer a variety of CD term lengths, and most will require a minimum deposit in order for you to open the CD. In most cases, the longer the CD term you agree to, the higher your rate of return
Certificates of deposit are commonly referred to as “safe” investments, due to the fact that they are insured, like other traditional bank accounts. As long as the financial institution offering the CD is FDIC
insured, any deposits you have there that don’t exceed $250,000 will be covered. Some financial institutions even offer additional coverage for deposits that exceed FDIC or NCUA limits. BankFive, for example, is part of the Depositors Insurance Fund
, which insures all deposits in excess of the FDIC’s $250,000 coverage limit.
Another difference between a CD and a savings account is that with a CD, you typically “lock in” your rate for the entire term. So, if you open a 12-month CD with an annual percentage yield of 0.35%, but then two months later the bank changes the rate of that CD to 0.25%, you’ll still be locked into your 0.35% rate. With a savings account on the other hand, your rate of return will typically change
every time the bank changes that product’s interest rate.
CDs also differ from savings accounts in that they don’t usually allow you to add additional funds after the term length begins. With a savings account you can deposit funds on a daily, weekly, or monthly basis, helping to grow your nest egg. With a CD on the other hand, you generally make your entire deposit when opening the account, and let the interest rate grow your funds over time.
In some cases, it’s possible to withdraw funds from a CD before the maturity date, but doing so will typically result in an early withdrawal penalty fee. For this reason, you should only place money in a CD if you’re confident you won’t need it before the term length is up.
The most common CD term lengths range from six months to five years, with various terms in between that time-frame. When a certificate of deposit matures, you generally have the option to either withdraw your deposit and the interest earned, or roll the funds over to new term.
Locking in a rate with a CD is all well and good when CD rates are on the decline, but what if you lock in a CD rate only to find that the product rate increases
a few months later? With a traditional CD, you would miss out on the new higher rate, since you were already locked into the lower rate. In a climate where CD rates are expected to increase, one variation to consider is a bump-up CD
. A bump-up CD allows you to request an increase to your current CD interest rate if the product rate has been adjusted since you opened the account. For example, if you open a 30 month bump-up CD
at 0.45% APY, and six months into your term your bank increases the rate of that product to 0.65% APY, you can request to be “bumped-up” to that current, higher rate.
Different financial institutions will have different constraints for bump-up CDs and it is important to understand the unique terms of the account before committing to it. Many banks will only allow you to bump up your rate once during the CD’s term length. Therefore, if you bump up to a higher rate and then the product rate increases again, you will no longer be eligible for a rate increase. Other banks may permit a second rate increase only if you extend your CD’s term.
Another benefit of a bump-up CD is that if you bump up your rate and the bank later decreases the rate of the product, you are still locked into your “bumped-up” rate. Thus, a bump-up CD can give you a bit of control and protection from fluctuating CD rates. One potential downside of a bump-up CD is that the initial interest rate you’ll receive is typically lower than what you would receive with a traditional CD of similar term length. In other words, the interest rate at account opening will usually be lower for a 12 month bump-up CD than a regular 12 month CD. For this reason, it makes sense to invest in bump-up CDs when overall CD rates are low and expected to rise again
during the term length.
While a traditional CD will typically not permit you to add funds after account opening, an add-on CD
allows you to do just that. With an add-on CD
, you can usually add money to the account at any time during the term length, like you can with a savings account. This allows you to grow your investment at a faster rate since you can earn interest on both your initial deposit and the funds you add over time. You can also still benefit from locking in an interest rate that is typically higher than a traditional savings account. Be aware though, that the terms and conditions for add-on CDs will differ depending on the financial institution offering them. Some may have restrictions on how much, or how often, you can deposit money into the CD. Because of this, it’s a good idea to read all of the fine print associated with the CD before opening your account.
Like a traditional CD, your money is “locked” for the duration of the CD term when you open an add-on CD. This includes any funds that you add to your initial deposit over time. Because of this, it is important to be sure you will not need those funds before the CD matures, as you will likely face a penalty for withdrawing money from the CD early.
Find the CD that’s right for you.
No matter which CD option you are considering, the most important thing is to understand exactly what you are agreeing to. If you have funds that you won’t immediately need, a certificate of deposit can be a safe way to grow your investment over time, and a bump-up CD or add-on CD could provide you with additional flexibility if needed.
BankFive offers a variety of CD options
for you to consider, including a 30-month bump-up CD
, and a 2-year add-on CD that we refer to as our 2-Year Investment CD
. If you have any questions about investing with certificates of deposit, don’t hesitate to contact us