If you’re looking for a place to hold money you can’t afford to lose, but want to earn a higher interest rate than a checking account, two options should make your short list: savings accounts and certificates of deposit. Typically, CDs are used for longer-term savings when you know you won’t need the money for a certain period of time. Savings accounts have more flexibility, which make them ideal for emergency funds.
Accessibility of Funds
Certificates of deposit restrict your access to the money for the term of the CD. If you withdraw your money from the CD early, you’ll pay a hefty penalty. The penalty varies depending on the length of your CD: Typically, the longer the term of the CD, the larger the penalty. For example, you might pay a penalty of three months of interest if the term is less than a year, six months of interest if the term is between one-and-five-years, and one year’s interest if the term is five years or more.
Savings accounts allow you to access your money more freely. Federal regulations restrict you to six pre-authorized, automated or telephone transfers and withdrawals from savings accounts each month. However, in-person transactions at a bank or ATM are unlimited. Basically, the government doesn’t want people to use savings accounts as checking accounts.
Account Interest Rates
The interest rates on CDs are typically higher than the interest rates on savings accounts. Among CDs, typically the longer the term of the CD, the higher the interest rate. However, before you get too excited, remember that if you have to withdraw the money early, you are likely to be paying a higher penalty. The interest rate on your CD is typically locked in for the entire term, though some CDs offer a bump-up feature, where you can adjust the interest rate to the current market rate.
Savings accounts, on the other hand, change the interest rate as the market rates change. So, if rates go up, you’ll start earning a higher interest rate on a savings account, but not a CD. But, if interest rates fall, your savings account will earn less, while the CD will be locked in at the higher interest rate.
For both CDs and savings accounts, you may be rewarded with higher interest rates if you deposit more money into the account.
Benefit of FDIC Insurance
One area that CDs and savings accounts are the same is when it comes to Federal Deposit Insurance Corporation insurance. Both types of bank accounts are covered by the FDIC for up to $250,000 per account type. That way, even if the bank goes out of business, you still get your money back.
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- How to Calculate Accrued Interest on a Quarterly Compounding CD