How Do Certificates of Deposit Mature?

Traditional CD Structure

• A certificate of deposit is actually a promissory note issued by a financial institution. The bank or other financial institution pays interest on the principal you use to fund a CD. The bank will offer various interest rates on CDs with different maturity dates. the investor purchases a CD and holds it for the length of time specified by the terms of the contract. If today is June 15 and you get a one-year CD, the CD will mature next year on June 15. At that time, you can cash in your CD and get your principal back along with the accumulated interest. You can choose to have the bank send you the interest payments monthly or at a set period rather than wait until the maturity date to receive them. However, by letting the interest accumulate, you will have earned more at maturity. At maturity, you can opt to take your money or “roll over” the money and continue with another identical maturity period, though the interest rate will be adjusted up or down to the current value, or you can purchase another CD with a different maturity term.
  
  

Maturity Dates

• When you purchase a CD, the issuing bank or financial institution will specify the length of time the CD must be held until it matures and the interest rate. Maturity dates typically range from as short a period of time as one month to as long as five years. Common periods are one month, three months, six months, one year, 18 months, and two, three and five years. The longer the period of time to maturity, the higher the interest rate paid. Extended maturity dates, such as three to five years, have pros and cons. If interest rates go up during that time, you will miss out since you are locked in until the maturity date. However, if interest rates drop while you hold the CD, you benefit by having your rate locked in.
  
  

Closing A CD Prior To Its Maturity Date

• Certificates of deposit allow you to earn a little better interest rate than a savings account, yet still be able to get to your money just as quickly as a checking or savings account. The trade-off is that if you close a CD prior to its maturity date, you must pay a penalty. For short-term CDs, this is typically a loss of three months of interest. For CDs with longer maturity dates, a loss of six months is common.
  
  

"Laddering" Maturity Dates

• A good way to utilize CDs, as funds for emergencies, is to stagger or “ladder” maturity dates. Rather than placing a lot of money in one CD, the laddering strategy is to divide the money up into several CDs with varying maturity dates. For example, you place $1,000 in a CD today with a one-year maturity date, another $1,000 in a CD with a two-year maturity date and $1,000 in a CD that matures in three years. Let’s say that nine months from now your hot water heater needs replacing. You can cash in your one-year CD early to pay for the repairs. You will have to pay a penalty, typically a loss of three months' interest, but the other CDs will continue to earn interest. This strategy also allows you to benefit from the better interest rates for the longer term CDs while having the option to withdraw needed funds quickly.
  
  

Nontraditional CDs

• Bank-issued CDs are insured by the Federal Deposit Insurance Corporation (FDIC) so you know your principal is guaranteed. There are, however, other financial institutions that offer special types of CDs, which may or may not be insured. A “callable” CD, for example, gives the right for the bank to “call” or terminate the CD prior to its maturity date. Other types of CDs, each having pros and cons, include bump-up CDs, liquid CDs, step-up or step-down CDs, variable rate CDs, and zero coupon CDs. With these CDs, the concept of a maturity date is the same, but each has different interest structures. These products are issued by investment firms, such as Fidelity, Charles Schwab, FISN and USAA, and are not usually available at your local bank.