How to choose the best CD: 5 questions to ask

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In today's high-rate environment, savers have a real opportunity to benefit from increased interest rates.

Certificates of deposit, or CDs, are a popular choice due to their fixed interest rates and stable returns. With rates as high as 5% or more, right now is one of the best times to open a CD. But before you take the plunge, it's essential to ask the right questions to make an informed decision.

1. What’s the interest rate?

The interest rate is the percentage of money you'll earn on your CD over the term. It directly affects how much return you'll get on your money. The higher the interest rate, the more money you'll make.

CD rates are usually fixed, meaning they remain the same throughout the term. This stability can be helpful because you know exactly how much you'll earn in interest.

Generally, longer-term CDs offer higher interest rates than shorter-term ones. When you commit to keeping your money locked away for a more extended period, the bank can use those funds to lend. In return, they're willing to offer you a better rate as an incentive.

By comparing different CD rates, you can find the best deal and maximize your earnings.

2. What’s the minimum deposit requirement?

The minimum deposit requirement is the minimum amount of money you need to deposit to open a CD. These minimum deposits can vary significantly. For instance, some have no minimum deposit, while others ask you to fork over $25,000 before opening an account.

Typically, CDs with higher minimum deposit requirements will have higher interest rates.

Even if you have the funds, consider if tying up that amount of money in a CD aligns with your financial goals. If the minimum deposit is high and stretches your budget, it might be wiser to look for a CD with a lower requirement.

3. How long is the term?

A CD’s term is the time you’re willing to keep your money invested in the CD without touching it.

The term of a CD can vary, ranging from a few months to several years. As we mentioned before, the longer the term, the higher the interest rate you can usually get. So, if you want to maximize your earnings, a longer-term CD might be the way to go.

Remember that once you've deposited your money in a CD, it's not easily accessible until the term ends.

Before you jump into a long-term commitment, think about your financial goals. Are you saving for a short-term expense, like a vacation or a down payment? In that case, a shorter-term CD — like a 6-month CD or 1-year CD — might be a better fit, as you'll have access to your money sooner.

You also may want to think about larger economic trends. If you think interest rates will rise, you may opt for a shorter-term CD and reinvest at a rate that will (hopefully) be higher in the future.

4. Are there early withdrawal penalties?

Early withdrawal penalties are fees you may incur if you withdraw your money from a CD before its maturity date. Since CDs are meant for long-term savings, these penalties act as a deterrent to encourage you to keep your money invested for the entire term.

The amount of penalty varies depending on the bank and the specific CD.

Before opening a CD, carefully review the terms and conditions. Take note of the CD's terms and the penalties. This will give you a clear idea of what you're getting into.

CDs aren’t a good place for an emergency fund because of this penalty. Consider a high-yield savings account, which is much more accessible.

Some banks offer no-penalty CDs, which allow you to withdraw your funds before the term date without penalty. Although the interest rates may be lower, it can be a good choice if you anticipate needing access to your funds.

5. How is interest paid out?

CDs typically earn compound interest, which means they earn interest both on the initial deposit and interest earned. Compounding frequency happens daily or monthly, depending on the bank. Interest will start to accrue as soon as you deposit your money.

Different CDs offer different ways of paying out interest. Some CDs pay the interest at regular intervals, such as monthly or quarterly. Others may accumulate the interest and pay it out at the end of the CD's term. Knowing how the interest is paid can have an impact on your finances.

If you prefer a steady cash flow, a CD that pays out interest regularly can be beneficial. It provides you with consistent payments that you can budget and manage effectively. This can be a good choice for retirees or anyone looking for a reliable income stream.

If you don't need cash immediately, consider a CD that accumulates the interest and pays it out at the end of the term. This allows the interest to compound, potentially earning you more money in the long run.

The bottom line

There are several things to consider before opening a CD. Pay attention to the CD’s interest rate, minimum deposit requirements, and term length. You’ll also want to review any early withdrawal penalties.

If you have a specific goal and don't need immediate access to your money, a CD may be a good choice. These accounts provide a higher interest rate compared to traditional savings accounts.

But if you think you’ll need the money in the short term or want more flexibility, there may be better options.

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