Definition
A Certificate of Deposit (CD) is a savings product offered by banks, credit unions, and other financial institutions. It requires a minimum deposit and is fixed for a specified term. Often, the term ranges from a few months to several years. In return for locking in their money for this period, account holders generally receive a higher interest rate than they would from a typical savings account.
Examples
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John’s 1-year CD: John invests $5,000 in a 1-year CD with his local bank, which offers a 1.5% annual interest rate. By the end of the year, John will have earned $75 in interest, bringing his total balance to $5,075.
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Mary’s 5-year CD: Mary decides to place $20,000 in a 5-year CD from her credit union at an annual rate of 3%. Over five years, she will accumulate $3,185.48 in interest, resulting in a total balance of $23,185.48.
Frequently Asked Questions (FAQs)
What happens if I withdraw money from a CD before its term ends?
Withdrawing money from a CD before its maturity date typically incurs an early withdrawal penalty, which can be a loss of some or all of the interest earned.
Are CDs safe investments?
Yes, CDs are generally considered safe investments as they are insured by the FDIC (Federal Deposit Insurance Corporation) up to $250,000 per depositor per institution.
How are CD interest rates determined?
Interest rates on CDs are determined by various factors, including the length of the term, the amount of the deposit, and prevailing economic conditions.
Can CDs be renewed?
Yes, many banks and credit unions offer an automatic renewal feature, allowing your CD to rollover into a new term at the current interest rate when it matures.
- Term: The duration for which the deposit must remain in the account, typically ranging from a few months to several years.
- Yield: The earnings generated and realized on an investment over a particular period, shown as a percentage.
- Interest Rate: The annual percentage rate earned on the deposited principal amount in the CD.
- FDIC Insurance: Protection provided by the Federal Deposit Insurance Corporation, covering deposits up to $250,000 per depositor, per insured bank.
Online Resources
References
- FDIC. “Certificates of Deposit.” FederalDepositInsuranceCorporation.gov.
- Bankrate. “Top CD Rates.” Bankrate.com.
- The Federal Reserve. “Consumer’s Guide to CDs.” FederalReserve.gov.
Suggested Books
- The Truth About Money by Ric Edelman
- Finance for Normal People: How Investors and Markets Behave by Meir Statman
- I Will Teach You to Be Rich by Ramit Sethi
Real Estate Basics: Certificate of Deposit (CD) Fundamentals Quiz
### What generally happens when you withdraw money from a CD before maturity?
- [ ] No penalties are incurred.
- [ ] You incur a monthly service fee.
- [x] You typically pay an early withdrawal penalty.
- [ ] The interest rate increases.
> **Explanation:** Withdrawing money from a CD before its maturity usually incurs an early withdrawal penalty, which can lead to forfeiting part or all of the interest earned.
### How are CDs typically insured?
- [ ] No insurance
- [ ] Private insurer
- [x] FDIC insurance
- [ ] Bank-owned insurance
> **Explanation:** CDs are typically insured by the FDIC, up to $250,000 per depositor per financial institution.
### What factor predominantly influences the interest rate of a CD?
- [ ] Location of the bank
- [ ] Customer service rating
- [x] Length of the term
- [ ] Number of bank branches
> **Explanation:** The interest rate of a CD is predominantly influenced by the length of its term, along with the amount of deposit and prevailing economic conditions.
### Are the funds in a CD liquid?
- [ ] Yes, they can be accessed at any time.
- [ ] Partially, up to 50% can be accessed.
- [ ] Under specific conditions only
- [x] Generally, no, not without an early withdrawal penalty.
> **Explanation:** Funds in a CD are generally not liquid and withdrawing them before maturity might include penalties.
### How does the interest rate of a CD compare to a regular savings account?
- [x] Higher
- [ ] Lower
- [ ] The same
- [ ] It's not calculated the same way.
> **Explanation:** CDs usually offer a higher interest rate compared to regular savings accounts because account holders agree to lock in their funds for a specified term.
### Can a CD term be for a period as short as one month?
- [x] Yes
- [ ] No, it must be at least six months
- [ ] Must be at least one year
- [ ] Must be at least three months
> **Explanation:** Some financial institutions offer CD terms as short as one month.
### Who primarily offers CDs as part of their financial product offerings?
- [ ] Stock markets
- [ ] Online retailers
- [ ] Real estate agents
- [x] Banks and credit unions
> **Explanation:** CDs are primarily offered by banks, credit unions, and other financial institutions.
### Is the yield on a CD influenced by the principal amount deposited?
- [x] Yes
- [ ] No
- [ ] Sometimes, depends on bank policies
- [ ] Only for amounts above $100,000
> **Explanation:** The yield on a CD can be influenced by the principal amount deposited, with higher amounts often earning better interest rates.
### Can interest be compounded during the term of a CD?
- [x] Yes
- [ ] No
- [ ] Only in savings CDs
- [ ] Only when deposited above the insurance limit
> **Explanation:** Interest on CDs can sometimes be compounded, leading to earning interest on the interest accrued over the term.
### Can a CD be automatically renewed upon its maturity?
- [x] Yes
- [ ] No, must be manually renewed
- [ ] Only if the term is under one year
- [ ] Depends on the original term
> **Explanation:** Many financial institutions offer an automatic renewal option that allows a CD to rollover into a new term at the prevailing interest rate upon maturity.
