The most popular type of certificate of deposit, or CD, is the traditional CD. But there are a growing number of financial institutions that are offering new forms of CDs that have increased flexibility, for both the investor and the institution. If the traditional CD has always seemed to rule-bound for you, you may want to sacrifice some yield for more flexible options. The Traditional CD With a traditional CD, you deposit a fixed amount of money for a certain time period and, in return, you receive a pre-set interest rate. At the end of the time period, or term, you can either cash out the CD or roll it over for another term. Most banks will allow you to add additional money during the term or when you roll the CD over. If you withdraw the money before the end of the term you will be subject to stiff penalties that will result in the loss of interest and even principal. There are federal regulations that control the minimum early withdrawal penalty - there is no maximum penalty regulation. Institutions must disclose all penalties and terms when the account is opened. The Bump-up CD If you are worried that rates are on the rise, and you don't want to commit your money too soon, a bump-up CD may be right for you. This allows you to take advantage of rising rates. For example, you buy a two-year CD at a set rate, and six months into the term the bank offers an additional 0.25% on two year CDs. A bump-up CD is designed to give you the option of telling the bank that you want to "bump up" to that new rate. You will usually be allowed to do this once a term. The disadvantage is that you will usually have a lower initial rate than on a traditional two-year CD. If rates take a long time to rise, you won't make up for the earlier, lower-rate portion of the term unless the rates go quite high. Be sure that you understand where rates are expected to go before you buy a bump-up CD. The Liquid CD Want a CD with the convenience of a savings account? The liquid CD offers consumers the opportunity to withdraw money from the CD without penalties. There may be minimum balance requirements on the account. The interest rate will usually be higher than the rate on a money market rate, but less than a traditional CD of the same term and minimum. Federal regulations state that no money can be withdrawn without penalty until the money has been in the account for seven days. After that the first-penalty withdrawal can occur anytime according to the banks terms. Make sure that you have and idea how long after opening the account you will need to make a withdrawal. There may also be limitations placed on the number of withdrawals per term. You will have to decide if the convenience of liquidity is a greater advantage than traditional CDs. The Zero-coupon CD The zero-coupon CD works the same way as a zero-coupon bond, there are no interest payments. You buy the CD at a deep discount to the par value - the amount you receive when the CD matures. With a zero-coupon CD, you buy a $100,000 CD with a 10 year term at a 7% interest rate for $50,000. During the 10 year term, you will not receive any interest payments. The money is being invested. You will not be able to receive any income off of the CD each year, but you will be taxed on it. The first year you will owe taxes on the $3500 that you haven't even received yet. Each year you'll have a bigger tax bill. You have to know in advance that you have enough money to pay the taxes on this CD. Callable CDs If a CD is issued on a callable basis, the bank has the authority to "call" on it after the pre-set call-protection expires, but before the actual CD maturity date. For example, if you buy a 5 year CD with a 6 month call protection period, the bank can call the CD back if rates fall after the first six months. This is the bank's way of protecting themselves from having to pay out a higher interest than the going rate. If they issue a CD at 4 percent and six month later, the rates drop to 4% on 5 year CDs, the bank will call the CD. You receive your full principal back and any interest earned to date. The bank will usually pay a quarter to half a percent more on callable CDs than traditional CDs, because you are assuming the interest risk. Brokerage CDs Brokerage CDs are sold through a brokerage. Banks often use brokers as sales representatives to locate investors who want to purchase CDs. Brokered CDs are more competitive and will often pay higher rates than CDs from your local bank. These CDs can be traded like bonds on the secondary market, but there is no guarantee that you won't take a loss in trading. The only way to be sure that you will receive your full principal and interest is to hold the CD until it matures. Most brokered CD have call options included and are backed by the FDIC. High-yield CDs Banks are competitive when it comes to selling CDs. They will offer better than average rates just to secure your money. Look at the top 100 highest yield CDs for the best possible rates. |
