Certificates of deposit were once plain-vanilla investments without the 31 flavors. But as banks try to woo customers during low-interest times, they've needed to sweeten their CDs. And high-yield CDs also may carry stiff early withdrawal penalties, and juicy advertised rates may come with caveats.
Investors are warned that scoping out CD details before buying is critical.
First, know your CD's annual percentage yield, or APY, and when it matures. A fixed rather than variable yield is best, says Robert Laura, president of Synergos Financial Group in Howell, Mich. That way, you can compare CD APYs among banks and compute yearly income.
Also, the CD maturity date is a key factor. According to the Securities and Exchange Commission, many investors forget to confirm the maturity dates when buying CDs. Ask to see the maturity date in writing, the SEC says.
But that's not all. Here are five lesser-known tips for navigating the CD market.
Know your grace periods
Grace periods are set times when you can withdraw your CD or make changes to it. They usually last seven to 10 days, says Greg McBride, CFA, senior financial analyst at Bankrate.com. But there's a hitch. Missing a grace period may mean getting locked into a lower rate when your CD matures. Why? Most banks will automatically renew at the current yield. And it could be at a lower rate.
Laura advises to mark the dates on your calendar. "Pay attention to this grace period," he says.
Also worth noting: Your CD usually doesn't pay interest during the grace period.
Promotional yields may not apply
Restrictions usually accompany advertised CD interest yields, Laura says. Why? These are promotional CDs meant to woo customers into new accounts. CDs aren't moneymakers for most banks, so they also will want to sign you up for direct deposit or for a debit card. Also, promotional CDs also may have longer maturities or require higher balances.
Before plunking down money, ferret out any conditions attached to high promotional CD yields.
Withdrawal penalties can be steep
A whopping 92 percent of all CDs will dig into principal to satisfy early withdrawal penalties, according to a Bankrate.com survey. And these penalties, which vary widely among banks, can be even stiffer with longer-term CDs. So, if you end up needing money locked away in your CD, you'll pay dearly.
For example, JPMorgan Chase & Co. charges $25, plus 3 percent of the withdrawal amount, for early CD withdrawals on CDs that mature in one year or more. The result: a $325 penalty on a $10,000 deposit.
Brokered CDs usually have fees
Brokerage firms typically buy CDs from banks nationwide and then resell them to customers for a fee. The cost is subtracted from the yield, which might be lower than you think. Also, a transaction fee, which you pay the broker directly when buying the CD, also may be applied.
So, opt for brokered CDs that yield at least 1 percent annually. "Otherwise, they're not worth it," Laura says, since you must make up for brokers' fees by nabbing even higher yields.
Also, stronger banks usually don't sell their CDs via brokers, adds Herb Hopwood, president of Hopwood Financial Services in Great Falls, Va. So, vetting the bank with Bankrate.com's Safe & Sound ratings is important. "There's more to be aware of when buying brokered CDs," Hopwood says. "You need to be an educated shopper."
On the plus side, yield-hungry investors can cast a much wider net among banks, Hopwood says. Also, brokered CD holdings spread among many different banks, such as Wells Fargo Bank and Citibank, can appear on one statement.
Avoid the secondary CD market
Brokerage houses such as Fidelity and Charles Schwab & Co. also offer secondary CD markets. These are markets where previously issued CDs are bought by and sold to investors. But trading is minimal.
CD pricing varies widely, depending on market demand, much like buying a stock. You may end up losing principal because the CD may sell for less than what you paid for it, Hopwood says.
Penalties for early withdrawal are more punitive than what banks charge. That's because the only way to break a brokered CD before maturity is selling it on the secondary market, Hopwood says. "If you buy a CD from a broker, intend to hold onto it," he says.
Final advice: Start CD shopping via your local bank. "Banks are rewarding relationships these days," McBride says. You may find the best CD right in your own backyard.
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