What do you mean by certificate of deposit?


Many people do not know what a certificate of deposit is. They want to know the certificate of deposit definition, besides how many types of certificate of deposits there are, and many other things about them. However, now this mystery will be solved through this article, which will educate you about what a certificate of deposit really is and what all it entails. 

Certificate of deposit definition

A Certificate of Deposit is also known as a CD, which is its short form. It is a type of savings certificate in which the bearer can receive the interest. CDs are relatively low-return and low-risk investments, which are suitable for cash that you do not need for months or even years. 

Every CD has a specified fixed interest rate and a maturity date. If you abandon the money that you put into it for the investment period (called the ‘duration’ or ‘term’) or till the CD matures, then you get and interest on it that is slightly higher than a checking account or a money market. Also, CDs can be issued in any value or denomination. All gains from a CD are taxable as income, except if they are in a tax-free (Roth IRA) or a tax-deferred (IRA) account. 

Generally, commercial banks issue CDs and FDIC (Federal Deposit Insurance Corporation) insures it. Besides this, CDs are also issued by credit unions, where they are insured by NCUA (National Credit Union Administration). Certainly, these institutions have their restrictions as to what they will insure and what they will not. Furthermore, the period of CD, till it is valid, is known as term. It can usually vary from one month till five years. 

Certificate of deposits are one of the safest type of investments that a person can make. This is because the interest rate you get on it is specified in advance. Plus, it is guaranteed that you will get back your money, in addition to the interest on the maturity of the CD. Besides this, if the credit union or the bank that issues your CD goes kaput, your deposit is almost certainly insured by the NCUA or FDIC till $250000. 

Image courtesy: Wikimedia
Image courtesy: Wikimedia

A certificate of deposit is much more than the above mentioned certificate of deposit definition. A CD is a promissory note, which is issued by different banks and credit unions. It is a type of time deposit in which the holders are restricted to withdraw their funds on demand. However, CD holders can still withdraw their money by paying a withdrawal penalty, as specified by a bank. This withdrawal penalty varies from one CD to another, as per its term and the issuing bank. 

You can understand this better with a small example. Let us say that you invest in a certificate of deposit worth $10000 that has 5 per cent as its interest rate, which is compounded annually. Its term is 1 year. When one year ends, the CD will increase to $10500, which is $10000 x 1.05. 

Now, you know certificate of deposit definition and how you can calculate the total amount with its rate of interest. Moreover, you must know that CDs that are below $100000 are referred to as ‘small CDs’ and CDs that are above $100000 are known as ‘jumbo CDs’ or ‘large CDs.’ You can negotiate some of the small CDs and almost all of the large CDs.

 Types of CDs

After learning the certificate of deposit definition, now you should learn about the different types of CDs that are available in the market. These are some of the most common types of certificates of deposit. 

  1. Traditional CD

This is a type of CD, where you get a fixed interest rate for a specific time period. And, when that term finishes, you can roll your money into another CD or withdraw it. However, if you withdraw your deposit before its maturity date, you have to pay a hefty penalty on it. 

  1. Liquid CD

This type of certificate of deposit enables you to withdraw a part of your deposited money, without paying any withdrawal penalty. However, the interest rate on such kinds of CDs is generally a little bit lower as compared to other CDs, even though it is still higher to the interest rates that you get in a money market account. 

  1. Bump-Up CD

    Image courtesy: JPhotoStyle.com
    Image courtesy: JPhotoStyle.com

In a Bump-Up CD account, you have the freedom to swap the interest rate that you get in your existing CD to a higher interest rate, in case the interest rates on new CDs of the same duration increase during your investment period. However, many institutions that offer Bump-Up CDs allow you to bump up your certificate of deposit only once during your CD term and then its rate of interest remains the same for the remaining original term of your CD. 

  1. Callable CD

 A callable certificate of deposit is the one, where its issuing bank can recall the CD after a specific period of time. And, when it does so, it will return your CD deposit, in addition to the owed interest. These types of CDs are issued by banks, when the rates of interest fall considerably below the initial interest rates. Banks usually do this to make these types of CDs attractive to consumers and thus pay a higher rate of interest on them. Also, callable CDs are generally provided through brokerages. 

  1. Zero-coupon CD

In a zero-coupon CD, you do not get any annual interest rates, but the payments are reinvested in order to give interest rates on a higher amount of deposit. In these kinds of CDs, you get a slightly higher interest rate as compared to other certificates of deposits. Nonetheless, you have to pay taxes on the reinvested interest. 

  1. Brokered CD

    Image courtesy: The Blue Diamond Gallery
    Image courtesy: The Blue Diamond Gallery

Any type of certificate of deposit that is provided by a brokerage is known as a brokered CD. Brokerages can access multiple CDs offered by brick and mortar banks as well as online banks. Generally, such types of CDs offer high interest rates from smaller and online banks, since they are nationally opposing for the money of the depositors. However, you have to pay some fees in order to buy a brokered CD account. 

Thus, you can choose the right kind of CD for yourself among these. This way you can grow your money with solid returns, without much risk. A CD can also help to contribute in your overall savings plan, with the backing of the federal government.