Conventional savings accounts offer relatively low rates of interest. The rates for checking accounts, if they even pay interest at all, are usually minuscule. For those looking for higher rates of interest, banks offer money market accounts and certificates of deposits (CDs). Both types of accounts usually have higher minimum balances than conventional savings accounts.
For a money market account, the bank invests the money in securities offered by governments and corporations and gives the customer an interest rate based on the prevailing “money market rates,” which fluctuate. Customers have limited abilities to draw money from these accounts. Withdrawals over a specified limit may be subject to extra fees.
Certificates of deposit usually pay better interest than money market accounts. The bank offers CDs for specific amounts and for specific maturation periods: six months, a year, three years, five years, or more. Usually, but not always, CDs requiring greater deposit amounts and longer maturation periods earn higher interest rates. The bank locks in the rate, while the depositor agrees to accept penalties for withdrawal or closure of the account before maturity. These penalties are specified at the outset of the CD and may not be changed afterwards by the bank. In addition to a specific financial deduction from the account as a penalty, early withdrawal might result in the loss of some interest, a good example being the loss of the final six months worth of interest for early cancellation of a five year CD. The depositor must hence consider whether he or she will need the money before the CD’s maturity date, as well as the relative risks and rewards in attempting to gain a higher return through other investment vehicles.
Before a CD matures, banks notify the holder of the certificate of the impending maturation date, allowing a short period during which the holder may cash in the CD without penalty or, as the bank usually prefers, “roll over” the funds into a new CD or other vehicle.
In an effort to stay competitive, some banks issue CDs that allow the rates to be raised, on a limited basis, should prevailing interest rates rise.
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