Certificate of deposit facts for kids

A certificate of deposit (CD) is a special way to save your money at a bank or credit union. When you open a CD, you agree to keep your money with the bank for a set amount of time, usually from a few months up to five years. In return, the bank pays you extra money called interest, which is like a reward for letting them use your money. The longer you keep your money in the CD, the more interest you usually earn. However, if you need to take your money out before the agreed time is over, you might have to pay a penalty fee. CDs are popular in the United States because they often offer higher interest rates than regular savings accounts.

What is a Certificate of Deposit?

A certificate of deposit, or CD, is like a special savings account where you promise to leave your money untouched for a specific period. Think of it as a mini-contract with the bank. You lend them your money for a set time, and they promise to give it back with extra earnings (interest) when the time is up. This makes CDs a safe way to grow your savings because the interest rate is usually fixed, meaning it won't change even if other interest rates go up or down.

How CDs Work

When you get a CD, you choose how long you want to keep your money in it. This is called the "term." Common terms are 3 months, 6 months, 1 year, 2 years, or even 5 years. The bank then tells you the interest rate you will earn. This rate is usually higher for longer terms.

• You deposit money: You put a certain amount of money into the CD.
• You agree to a term: You pick how long your money will stay in the CD.
• You earn interest: The bank pays you interest on your money during the term.
• Maturity: When the term ends, your CD "matures." You get all your original money back, plus all the interest it earned.

Why Choose a CD?

People choose CDs for a few main reasons:

• Higher Interest: CDs often pay more interest than regular savings accounts. This means your money grows faster.
• Safety: CDs are very safe. They are usually insured by the government (like the FDIC in the U.S.), so your money is protected even if the bank has problems.
• Predictable Earnings: The interest rate is usually fixed, so you know exactly how much money you will earn by the end of the term.

Understanding Penalties

The main rule with a CD is that you shouldn't take your money out early. If you do, the bank will charge you a penalty. This penalty is usually a portion of the interest you would have earned. For example, if you take money out of a 1-year CD after 6 months, you might lose 3 months' worth of interest as a penalty. This rule encourages people to keep their money in the CD for the full term.

Types of CDs

While the basic idea of a CD is simple, there are a few different types that banks offer:

Traditional CDs

This is the most common type. You deposit your money, choose a term, and earn a fixed interest rate until the CD matures.

Jumbo CDs

These are CDs for very large amounts of money, usually $100,000 or more. They often offer slightly higher interest rates because of the large deposit.

No-Penalty CDs

Some banks offer "no-penalty" or "liquid" CDs. These allow you to withdraw your money before the term ends without paying a penalty, usually after a short waiting period (like 7 days). The interest rates on these might be a little lower than traditional CDs.

Callable CDs

With a callable CD, the bank has the option to "call" or close your CD early. If interest rates drop, the bank might call your CD and pay you back your money plus interest. This means you might not get to keep your money in the CD for the full term if rates change.

Step-Up and Bump-Up CDs

• Step-Up CDs: The interest rate on these CDs increases at set times during the term. For example, it might start at 1% for the first year and then "step up" to 1.5% for the second year.
• Bump-Up CDs: These CDs allow you to "bump up" your interest rate once or twice during the term if market rates go higher. This means you can get a better rate if interest rates increase after you open your CD.

CDs vs. Savings Accounts

Both CDs and savings accounts are ways to save money, but they work differently.

• Savings Accounts: These are flexible. You can put money in or take money out whenever you want without penalties. However, they usually offer lower interest rates.
• Certificates of Deposit (CDs): These offer higher interest rates but are less flexible. You agree to keep your money locked away for a set time, and there's a penalty if you withdraw it early.

CDs are a good choice if you have money you won't need for a while, like money you're saving for college in a few years or a big purchase far in the future. If you need easy access to your money, a regular savings account is better.