If you're looking at investing your savings over a long period, one type of savings account you might consider looking at is a certificate of deposit. Also known as CDs, these accounts are an agreement between you and the financial institution that requires you to set aside a pre-determined amount of money for a set time-frame, known as the term. In return, the financial institution will pay you interest on the money. The interest rate that you’ll earn will vary with the financial institution and time-frame.
In a general sense, the longer the term, the higher the interest rate is on the account. With CDs, your money is technically locked in for the entire duration. If you want to withdraw your money before the time ends, then you will likely have to pay a withdrawal fee or forgo a part of the interest earned.
Factors That Determine Your Certificate of Deposit Interest Rates
If you have money you won’t need access to for a while, a CD may make sense. These types of savings accounts generally offer the best interest rate on your money. Here are the three key factors that determine what your CD interest rate will be:
- The length of time your CD is held by the financial institution. This could be anywhere from a few months to five years or even more. Some people will use the laddering technique to ensure that they have access to their money more often. Laddering will be explained later in this article.
- Current interest rate environment. Present economic factors play a role in how much interest a financial institution is willing to pay on your money. Many financial institutions will consider what the Federal Reserve decides in their meetings regarding changes in the Federal fund rate.
- Expected rate of return. The expected rate of return is what your financial institution expects to earn on the money you have deposited into the CD account. Your financial institution wants to make a profit on your money, which then covers any amount of interest they will be paying out to you.
Paying a penalty for withdrawing your money earlier than the term’s end-date can wipe out the benefit of opening a CD. Be sure that you can afford to go without a set sum of money before starting a CD. There are other savings account types out there that may be a better option for you.
Laddering Your Certificate of Deposit Accounts
One method people use when setting up several CDs with different end-dates on the terms is called laddering. For example, say you have a total of $10,000 that you can invest in CDs. You decide to break this amount into equal parts of $2,500 that can be put into a CD. You put the first $2,500 into a CD with twenty-four month term, the second for a term that is eighteen months, the third into a CD that has a twelve months term, and last equal part into a six-month CD.
You may earn a different amount of interest on each of these accounts since the terms are different. However, you have access to part of your funds more often. This laddering method could help if you have an unexpected expense where you will need money sooner than later. It also minimizes the chance that you’ll have to access funds prematurely and forgo the interest earned or pay a withdrawal fee.
Savings Accounts Versus Certificate of Deposit
A CD will generally pay you a much higher interest rate on your money than a standard savings account. For an example, if you have $10,000 available to invest in a savings account or CD you may earn the following percentages: Bank interest rate of .06%, Credit Union interest rate of .13%, Bank CD for 60 months with .87%, and Credit Union CD for 60 months at 1.6%.
These numbers take into consideration the national averages and are computed monthly. Account fees and inflation are not considered in these earnings. Here is the summary of earning you would approximately obtain through each savings account type with interest mentioned above:
- Saving Account, bank - $31
- Savings Account, credit union - $66
- CD account, bank - $445
- CD account, credit union - $833
As shown, your interest-earning will be much higher when you have a CD account versus traditional savings. NASB has CD accounts that are easy to open and will lock in your rate for the term you choose. Do you have any questions? Feel free to call us today at 800-677-6272.