Certificate Of Deposit

What Is A Certificate Of Deposit?

A certificate of deposit (CD) is a product offered by banks and credit unions that offers an interest rate premium in exchange for the customer agreeing to leave a lump-sum deposit untouched for a predetermined period. Almost all consumer financial institutions offer them, although it’s up to each bank which CD terms it wants to offer, how much higher the rate will be versus the bank’s savings and money market products, and what penalties it applies for quick withdrawal.

Deeper Definition

When one deposits money and promises to leave it in the bank for six months or a year to earn a higher interest rate, the paper one gets representing the deposit is an example of a certificate of deposit. A certificate from a bank acknowledging the receipt of money and a promise to repay it at a specified time and with interest determined at a specified rate.

A certificate of deposit is essentially a fixed-term deposit at a bank, typically three months, six months, one year, two years, three years, etc. Individuals purchase a certificate of deposit with a lump sum of money. At the end of the term, the bank or financial institution returns the invested money in addition to a set amount of accrued interest.

The interest rate of the CD is typically fixed for the length of the CD. For instance, if one purchases a $500,000 2-year CD that pays 2% interest, at the end of 2 years, the bank will pay you $10,000 interest for the first year and $10,200 for the second year as the interest compound. The total return will be $520,200.

CDs can be redeemed early before the end of term, typically requiring a penalty of 6 months, one year, or more interest.