Best CD Rates

Getting the best CD rates is not always as easy as it seems it should be. But CD investors looking to find the best rate know that the prevailing interest rate, the size of the deposit, the length of the term, and the size of the bank are all primary factors in the rate of return.

Interest on CDs can be either simple or compounded. Simple interest is calculated by multiplying the rate by the amount of the CD at the end of the term. For example, if an investor purchases a 12-month CD for $10,000 that pays 2% simple interest, the investment will be worth $10,200 at maturity. Compounded interest is calculated at various points during the term and then added to the total. In other words, the interest that's credited to the account becomes part of the principal that earns interest. A 12-month $10,000 CD that earns 2% interest that is compounded quarterly would be worth $10,201.51 at the end of the term. While it might not seem like much, over time, and over multiple accounts, compounding makes an extraordinary difference in the amount an investor can save in a lifetime.

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Best Rates for CDs

A CD is certainly one of the safest financial investments one can purchase. While CDs are not typically appropriate for younger investors looking to grow their assets, they are appropriate for younger savers. And they are quite appropriate for older investors who are close to or at retirement age. CDs are low-risk investments that are insured by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures all CDs, even those that are sold by brokerage houses. While a traditional CD will not increase in value the way other investments will, it will typically pay more interest than a regular checking, savings, or money market account.

While there are other terms are available, the most common are six months, one year, and five years. Interest is paid on the CD at regular intervals and when you redeem it, you are paid the original purchase price along with the accrued interest. The best rates on CDs will be ones with longer terms, typically 36 or more months. Banks offer higher rates for longer terms because they can lend the money used to purchase the CD to other customers for a higher rate than they pay on the CD.

Types of CDs and How Interest is Determined

Finding the best rates on a CD will depend on the type of CD that is purchased. For example, a traditional CD usually pays the least and is the simplest type of CD. In exchange for holding the CD for the length of the term, the owner is paid a set amount of interest. A traditional CD is best for those who have short- to medium-term savings goals. Saving for a primary residence, a vacation home, even the vacation-of-a-lifetime are all good objectives of a traditional CD. But traditional CDs are interest rate sensitive. If rates rise before maturity, an investor will not benefit from the increase in rates.

A "bump-up" CD permits the owner to increase returns in as interest rates increase. Banks differ on how they allow the bump up to take place, but most will allow a CD owner to take advantage of this feature once per term. This can be extremely beneficial for those who are concerned about losing money on the investment as prices increase. In most cases, as interest rates rise, so do prices. The owner of a bump-up CD will be able to take advantage of the increase in rates, which may mean the investment will keep pace with rising prices.

A "liquid" CD gives the owner an opportunity to withdraw some of the money from the CD without incurring early withdrawal penalties. This type of CD often does not pay the best rates, as the bank is unsure as to how much of the money will remain in the account. Most banks will establish a minimum amount that must be maintained in the account in order to avoid penalties, but for the most part, a traditional or bump-up CD combined with a money market or savings account are a better alternative to a liquid CD.

"Zero-coupon" CDs are similar to zero-coupon bonds. The CD is purchased at a discount to its value. At maturity, the owner is paid the full face value of the CD. While this type of CD can often pay vary favorable rates, the downside is that the owner is taxed on earning that haven't yet been credited to the account. In other words, the bank does not pay regular interest on a zero-coupon CD. The full amount is not paid to the owner until the maturity date.

A CD that is "callable" can be a very lucrative investment for those who are willing to take the risk of losing the CD if interest rates fall. A callable CD is issued at one rate, which is typically higher, and then "called away" if the bank can offer a CD for the same term at a lower rate. The bank, however, pays the CD owner a premium for taking on this risk. This type of CD is more of an investment than a way to boost savings and is primarily suitable for those who can afford to "lose" the higher rate of return.

As the name implies, "High-yield" CDs often pay the highest and best rates of all. High-yield CDs are typically offer longer terms and are available for larger purchase prices. Banks compete for larger amounts for longer terms, and are therefore more willing to pay higher rates. And, smaller banks will often pay higher rates than larger banks because the amount of the CD represents a larger portion of the available capital they can then lend.

How to Find the Best CD Rates

Finding the best rates on CDs is usually easily done online. Even banks that operate exclusively online are required to meet the same federal and state requirements for capitalization as local banks. But with less overhead, online banks can sometimes offer more favorable rates.

Before choosing a CD, however, make sure it fits into the overall financial plan you've established. The CD should make sense as an investment or a savings vehicle and should not be entered into lightly. Unlike regular savings accounts, CDs represent a contract between you and the bank. Make sure to read and understand all of the interest and redemption features before purchasing any kind of CD.

While we've covered the basics of CD investing here, CDs should only be part of a long-term investment strategy. To make sure you're on the right track, contact a licensed financial advisor. It only takes a few minutes, Start Now.

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