Ah, college. A place of higher education, unforgettable memories, and more bills than the average student can afford. Along your path to getting a degree, you’ll often come face to face with a less than stellar bank account and have to figure out how to make your savings work for you. After all, that’s the best use of money – making it work for you. That’s why today we’re going to talk about opening a Certificate of Deposit, what it is, and how it’ll benefit you in the long run. Let’s get into it.
What is a Certificate of Deposit?
A Certificate of Deposit, also known as a Time Deposit or CD, is an account that typically offers a higher interest yield than a savings account but also requires the money to be left untouched for a set amount of time. For example, a CD might require you to deposit $500.00 with a six-month hold on the money at an interest yield of 1.0%. In that scenario, you’d earn approx $30.00 over six months.
CD terms can vary from 3 months to 5 years or more. When you open a CD, you’ll have a choice, based on your bank’s options, as to how long you want the money in the account. Once your CD matures, it enters the grace period. You can withdraw or add money to the CD during the grace period at no penalty. If you withdraw outside of the grace period, you may lose all the money you earned during that time. For example, if you have a six-month CD but withdraw the money during the 3rd month, then all the interest earned up to that point will be forfeited to the bank.
CDs, like most bank products, are written with jargon. Here’s a definition breakdown to help you through your next CD paperwork.
A term is the predetermined amount of time your money must be in a CD to avoid a penalty. In banking, the term is also used to specify how long you have to repay a loan.
When your CD reaches the grace period, you can make as many withdrawals as you wish, add money to the CD, or close the account. Typically, you’ll receive letters or emails from your bank letting you know the grace period is coming up. A CD grace period can last anywhere from 3 days to 2 weeks. While most CDs allow you to add money during the grace period, it’s not a guarantee. Check the CD’s terms and conditions during the opening to find out for sure.
Maturity means your CD is entering its grace period and, as such as has accrued the estimated interest. You have the choice of letting the CD auto-renew, which means your money will start a new term, and you’ll have to wait for the following grace period to avoid fees during withdrawal.
Fees for CDs often involve forfeiting the interest earned or a flat rate fee charge, whichever is greater of the two. Typically, fees are only applicable during withdrawals outside the grace period.
Most financial institutions need an opening deposit minimum when you start the account. This guarantees the bank or credit union will make a minimum amount for each new account. Opening deposits vary and can be as low as $25.00. For college students, it’s a solid idea to get a CD with a low opening deposit and invest in it over time.
Annual Percentage Yield
Annual percentage yield or APY is the money you earn from any given savings product. The higher the annual percentage, the more interest you earn. In 2022, the average interest rate for traditional accounts varied between .005 – 1.75%.
Fixed term means your interest rate during the account opening is fixed until the account is closed. For example, if you open an account and earn an APY of 1%, then you’ll always earn that exact APY. The benefit of a fixed term, which also applies to any credit product, is stability. You’ll always know how much you have to pay or stand to earn. The opposite of a fixed term is a variable rate.
A variable rate means your APY fluctuates based on the economy. The benefit of a variable rate is that it can potentially earn more than a fixed rate. However, variable rate values can also decrease, which means variable rates have a certain degree of risk.
CD vs. Money Market vs. Savings Account
Banking has tons of savings products that, when compared, can be a bit confusing. Here’s the difference between savings products and how they benefit you.
A savings account will typically have a lower interest yield than a CD. But, in return, a person can withdraw or deposit money whenever they need to with no fee. Plus, a savings account can come with an ATM card for convenience. Savings accounts always have an APY, but that can be as low as .005. To be clear, it’s impossible to earn any significant interest on an account with a yield of .005. Savings accounts terms and conditions vary between financial institutions. Reach out to yours and find out if you’re making the most of your money.
Biggest Pro vs. CDs
You can use the money in a savings account whenever you need it, unlike CDs where the funds aren’t readily available. That makes savings accounts an ideal choice for emergency funds.
Biggest Con vs. CDs
Significantly lower APY. If you have a large sum of money in your savings that you haven’t touched or don’t plan to touch, then open a CD and make your money work for you.
Money Market accounts are, in practice, a fusion of a savings and checking account. Typically, Money markets will have a higher APY than traditional savings while offering a debit card. Additionally, money market accounts often have a minimum balance and/or higher opening deposit requirements. Also, there’s a limit to how many times you can withdraw per month.
Biggest Pro vs. CDs
There’s a chance that a money market may have a comparable APY to some CDs. That means you can earn CD-level interest while also having the money accessible. Compare rates at your bank.
Biggest Con vs. CDs
More applicable fees. The only fee for a CD is the interest penalty if the money is withdrawn too early. However, money market accounts can earn fees based on balances, payments, overdrafts, etc.
Are CDs Right for Me?
While CDs are a great financial resource, they aren’t suitable for every situation. Here are three scenarios where a CD is the right choice and one scenario where it isn’t.
Saving for Something Big
Saving for something big can be a trip, car, tuition, etc. Putting the money in a CD is a great way to avoid touching it on a day-to-day basis and a great way to earn the most interest until your big purchase.
Time to Think
If you’ve recently received a large deposit from an inheritance, business profit, etc., and aren’t sure when or how you want to spend it, then put it in a CD. That’ll give you time to decide what you want in the long-term while also making the most of your money.
Looking for a Way to Start Saving
Some CDs have an opening deposit of approx $25.00. That makes them ideal for a person who wants to get at least used to the idea of savings. As the CD matures, add more money, and you’ll have a sizable balance before long. When your CD balance is getting high, close your current CD and open one with a higher yield. Rinse and repeat that process.
You Frequently Live on Savings
If you, on average, use your savings to pay end-of-the-month bills or survive between semesters, then a CD might not be the best option. As mentioned, funds in a CD aren’t fluid, meaning you can’t access them on a day-to-day basis. And attempting to do so will cause you to get penalties. If you want a higher APY, open a traditional savings or money market account instead.
What Do I Need to Open a CD?
Opening a CD can be done online or in person at any financial institution. The minimum opening deposit varies but can be as low as $25.00. Choose a term based on your financial goals and the specific APY requirements of the CD. Does it offer a higher yield for a higher balance? Always aim to maximize how much interest your accounts yield.
Disadvantages to CDs
The biggest disadvantage to a CD is that the money isn’t readily accessible. Plus, interest penalties can total all of your accrued interest. As mentioned, CDs shouldn’t be used daily or monthly.
CDs are a powerful financial resource in the right hands. And, they’re an easy way to start building a high-balance savings account without the risk of investing, trading, etc. As a college student, you can build your CD with the intent of putting it towards your student loans. The bottom line is this; savings accounts are crucial in college and adulthood. CDs are a great place to start building your safety net.