Certificates of Deposit (CDs) are a good option for savers who want to invest a portion of their nest egg in relative safety for a set amount of time. CDs are often lumped in with deposit accounts and similar savings vehicles, but they can play a much more significant role in your financial strategy.
CD classifications
Most CDs are of the straightforward variety, providing a fixed rate at a fixed term of typically three months to 10 years. While these low-risk investments generally offer smaller returns than their high-risk counterparts such as stocks, their set term does provide a higher interest rate than simple savings accounts.
Plus, CDs are insured by the FDIC for up to $250,000, adding an extra level of protection for CD funds up to this amount. This combination of protection and stability makes CDs one of the safest investments available.
There are several other types of CDs, however, that offer other options.
Variable-rate CDs
The rate for these CDs change depending on a few factors:
- An adjustable rate that allows you to increase the rate a set number of times if rates on such CD products happen to rise during the CD term.
- A "step-up" option that increases the rate automatically at set intervals.
- Indexed rates that are tied to the stock market, bonds, commodity prices or currencies.
Low/No-penalty CDs
Also known as "liquid CDs," this CD allows you greater access to your funds than traditional CDs that impose a penalty for withdrawing or transferring your money during the term. This liquidity usually results in a lower rate and requires a higher minimum balance.
Jumbo CDs
These CDs carry hefty minimum balance requirements, often $100,000 or more, but offer higher rates.
IRA CDs
Similar to other retirement fund vehicles, this certificate of deposit is held in a tax-advantaged IRA.
These alternatives may not be available at every financial institution, but they’re worth checking out if you have specific needs they can fulfill. CDs, however, aren’t just for saving.
CD ladders for liquid gains
You may be able to work around a CD’s lack of liquidity by using the CD ladder strategy. The basic premise is to set up a mini portfolio that contains several CDs of varying term lengths. When the shortest one matures, the money is rolled into a higher-earning, longer-term CD. This process is repeated as each CD matures, eventually providing a collection of steadily higher-yielding investments while simultaneously providing intermittent access to your funds. This boosts your return with both the previous interest that was gained and the increased interest of a longer-term CD.
Short-term loans
CDs can also serve an important purpose if you find yourself in need of funds to bridge a momentary financial gap. Borrowing against a CD can net you a much better rate than credit cards and payday loans since the debt is backed by collateral and is designed to be paid off within months rather than years. This means that a six-month CD-secured loan for $2,500 with a 3% interest rate would only cost you about $22. It’s important to keep in mind, however, that you may only be able to borrow 80% to 90% of the CD principal and other conditions and fees, including credit approval, will likely apply.
Credit building
The ability to receive a loan backed by your CD opens up another benefit: boosting your credit score. Financial institutions often report these installment accounts to credit agencies, giving you the chance to diversify your credit mix and build a positive payment history, both of which increase your score. The brief nature of these loans and your ability to pay them off quickly can provide a significant score bump in a short amount of time.
The information mentioned in this article is for informational purposes only, is intended to provide general guidance and does not constitute legal or tax advice. Each person’s situation is unique and may materially differ from the information provided herein. You should seek the advice of a financial professional, tax consultant and/or legal counsel to address your specific needs before any financial or other commitments regarding the issues related to your situation are made. Popular Bank does not make any representations or warranties as to the content contained herein and disclaims any and all liability resulting from any use of or reliance on such content.