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Shopping for a CD: Be Informed, Be Safe
With many investments in the stock market or real estate declining in value, certificates of deposit (CDs) remain some of the safest and most reliable places for your money. But as with most financial products and services, it pays to do some research and take other precautions before you buy.
CDs come in many varieties, so shop around. With a traditional FDIC-insured CD, you agree to keep the money in an account for a set term — a few weeks to several years. In return, the bank agrees to pay you a higher interest rate than you would receive from a checking or savings account. If you need the money back earlier, you can arrange that but expect to pay an early withdrawal penalty. However, the traditional CD now is only one of the choices.
"Many institutions have added innovative programs that give depositors new flexibility with CDs," said Sukari Smith, an FDIC Community Affairs Specialist. "Now you may be able to add money to the CD, switch to a higher interest rate or withdraw money early without a penalty. You need to look carefully and decide what makes sense for you."
When shopping around, ask these questions:
You may be able to get a good deal on a bank CD sold by a brokerage firm, but it also may come with extra risks and costs. Although most savers purchase CDs through local banks, firms known as "deposit brokers" compare rates at several banks and sometimes negotiate a higher interest rate by promising to bring a certain amount of deposits to an institution. But a broker-sold CD can be complex and may carry more risks than purchasing a CD directly from a bank. Before buying a CD from a broker, read and understand the fine print, and make sure you are dealing with a reputable broker. For more guidance, see "Certificates of Deposit: Tips for Savers," at www.fdic.gov/deposit/deposits/certificate.
Consider "laddering" your CD purchases over different time periods. Say you have $10,000 to invest and you'd like to maximize your earnings but you're hesitant about investing long term. Instead of putting it all into a five-year CD just to get a high, long-term interest rate, you could place $2,000 in a CD that matures in a year, $2,000 in a CD that matures in two years, and so on, which means you'll have a CD maturing every year for five years. If you follow the strategy, you'll roll each maturing CD into a new 5-year CD. But if you need the money for other uses, you will not have to pay an early withdrawal penalty.
(Editor’s Note: Due to the 2010 Dodd-Frank financial reform law, deposit insurance coverage has changed from what was published below. As of July 21, 2010, the standard federal deposit insurance amount was permanently increased to $250,000.)
Deposit with confidence knowing that federal deposit insurance of $250,000 will continue through 2013. As noted in Congress Extends $250,000 Insurance Coverage Through 2013, Congress has extended the temporary insurance limit of $250,000 per depositor (up from $100,000 per depositor) from December 31, 2009, through December 31, 2013. “The continuation of $250,000 insurance coverage is great news for depositors who want to purchase long-term CDs,” said Martin Becker, an FDIC Senior Consumer Affairs Specialist. “It means that between now and year-end 2013, if your funds are within the $250,000 federal insurance limit, you are fully protected if the bank fails.”
Beware of an advertised CD rate far above the competition. First, it could be a product issued by a company that is not federally insured and any money invested is at risk. Second, it could be a marketing ploy. "An offer of a very high interest rate may be a lure to promote the sale of non-insured products," said Richard M. Schwartz, an FDIC attorney who specializes in consumer issues. "Some non-bank companies are using the FDIC logo and good name to draw customers in the door for a bank CD, but sooner or later, they're going to try to lock them into a long-term investment that may not be in the customer's best interest."
In one variation, a company may advertise in the local newspaper a 5.0 percent interest rate for a six-month bank CD for consumers with $10,000 to invest. When a customer calls, he or she is told to come to the office to discuss the details. It turns out that the bank is paying only 2.5 percent — not 5.0 percent — but the sales person for the company offers to add enough money to the CD purchase to make up the difference. When the CD matures, there's no similar offer on a new CD and the individual can be steered into purchasing a non-insured investment that may be a poor choice for the consumer but very lucrative for the sellers.
Schwartz offers this final advice: "If you are purchasing a CD, verify that it is issued by a federally insured depository institution. Understand the interest rate and the terms offered. Finally, research the going interest rates from banks locally and around the country, and if you find an offer that sounds too good to be true, be aware that there will definitely be strings attached."
Last Updated 5/17/2011