A certificate of deposit, or CD, is a way to save money at a slightly higher rate of return than a savings account, and with considerably less risk than investing in the stock market, according to the Federal Deposit Insurance Corp. When you buy a CD, you agree to leave the money in it for a set amount of time. You can take out the money before it matures, but you usually have to pay to do so.
Certificates of Deposit Explained
The depositor usually must guarantee that the money will stay in the account for a set term, anywhere from one month to several years. Once the CD matures, you can withdraw the money you deposited plus any interest earned, or you can renew it for another term. CDs, like money in a savings account, were insured by the FDIC for up to $250,000 per depositor per bank as of mid-2011.
Penalties for early withdrawal vary from institution to institution and are based upon the term of the CD. On a six-month CD at a bank, you might need to pay three months worth of interest if you take the money out before the six months are up. You can lose money if you cash out a CD too soon. For example, if you cash out a six-month CD at two months, you will still need to pay three months worth of interest.
Exceptions to Penalties
There are several exceptions to early-withdrawal penalties. Some banks offer penalty-free CDs. If you choose a penalty-free CD, you will probably have to take all the money out of the account to avoid any fees. You usually must wait a week after opening the account to remove the money.
If the owner of a CD dies or becomes incompetent, an eligible person can withdraw the money without a penalty.
Brokered CDs operate differently than bank CDs. These are purchased through a broker, who is usually attempting to sell a certain number of CDs to get a better rate of return. Although some brokered CDs claim not to have withdraw penalties, according to the FDIC, you might still lose money if you cash them in before the maturity date. If you purchase a CD that pays 1 percent interest and decide to cash out before it matures, your broker will need to sell the CD to someone else. If interest rates have fallen since you purchased the CD, you might make money. But if rates have risen, for example to 2 or 3 percent, you will lose money because demand for your lower-interest CD won't be high.