Should I open a no-penalty CD?

By Sabrina Karl

Certificates of deposit are often touted as a way to earn money on your savings with virtually no risk. In terms of your principal staying intact, that’s generally true. But CDs do carry the risk of forfeiting some earnings should you cash out early. So why not invest in no-penalty CDs instead?

If you’re thinking that something that sounds too good to be true probably isn’t, you’re on the right track. No-penalty CDs aren’t a swindle, though. They’re legitimate products, offered by many reputable institutions. But though they might be smart for a particular type of saver, for most of us they leave too much money on the table.

No-penalty CDs are exactly what their name suggests: a certificate that imposes no early withdrawal penalty if you cash the CD out before its maturity date.

However, that withdrawal flexibility comes at the expense of a much lower interest rate. It’s as simple as this: If you want to maximize your earnings, you’ll need to commit to a full term, or pay the penalty if you break the contract. But if you opt to avoid penalties, the bank will pay you less interest.

The lower rate can be significant, too, to the point that you can generally find an online savings account that pays as much or more, with almost no withdrawal restrictions. So for most, it’s smarter to open a high-yield savings account if you can’t commit to a full CD term.

One scenario where a no-penalty CD can make good sense is for savers who feel they lack the discipline to keep their savings untouched. Though a no-penalty CD still allows access, it’s not as simple or quick as draining a savings account. And that added procedural obstacle might be just enough to keep them from tapping their savings.

Follow this checklist before locking into a CD

By Sabrina Karl

Although certificates of deposit are among the safest saving vehicles, not all are created equally. Indeed, since their very nature requires committing funds to sit untouched for an extended period, you’ll want to choose wisely before signing on the dotted line.

The first criteria you’ll want to consider is the interest rate. How much institutions pay varies widely in general, and additionally, many banks and credit unions offer limited-time promotional CDs. So anytime you’re in the market for a new CD, it’s worth searching the current top rates for your chosen term to create a short list of candidates.

The next checkbox is determining whether each institution is federally insured, by the FDIC (for banks) or the NCUA (for credit unions). Although you may feel comfortable opening a certificate with a privately insured institution, most savers opt to stick to accounts insured by the U.S. government.

With your list whittled to top-rate CDs from federally insured institutions, it’s time to check early withdrawal penalties. The amount the bank or credit union will charge if you cash out early ranges from completely reasonable to downright exorbitant. Avoid any CD where the penalty could eat into your principal, and then check which certificates will hit you with the lowest fee should you withdraw the money early.

These three criteria should lead you to a few great CDs. But if you’re still torn between otherwise-equal certificates, you can check their compounding periods (the more frequent the compounding, the more you’ll earn), or how customer-friendly their website is. Calling to ask questions can also give you a sense of their customer service.

The world of CD options is immense, but following the first three steps of this checklist will lead you a certificate that pays well while exposing you to very little risk.

How safe are my bank deposits?

By Sabrina Karl

For anyone stashing money in savings, nothing beats the safety of depositing it in the bank. In fact, with a small amount of homework, you can ensure that what you sock away will earn interest virtually risk-free.

The key to holding risk at near-zero is two-fold. First, the financial institution you choose matters. Banks insured by the FDIC and credit unions with NCUA insurance will protect you if the institution fails, is seized, or otherwise ceases to operate. So if an FDIC bank goes under, the U.S. government will return your funds in full.

Fortunately, the vast majority of institutions carry federal insurance, as evidenced by an FDIC or NCUA logo on their website and print materials. But it’s important to verify, as a small minority of institutions instead carry private insurance. Though some argue this equally protects you, most contend that no private insurer is as reliable as the federal government.

For those with substantial savings, it’s also important to consider how much you’re depositing. That’s because the FDIC and NCUA insure up to $250,000 for any one depositor at any one institution. If your savings fall below this threshold, you can ignore this. But note that all funds you’ve deposited with an institution – no matter the number of accounts – will apply towards the $250,000 limit.

So what to do if you have more than that on deposit? Fortunately, it’s as simple as diversifying across multiple banks or credit unions. As long as you stay below $250,000 per institution, your deposits will be fully insured.

Money deposited in a bank or credit union won’t earn as much as you might be able to in the stock market, but achieving a steady return with no risk to keep you up at night can be a worthwhile trade-off.

How are ARM rates calculated?

By Sabrina Karl

Adjustable rate mortgages, or ARMs, can be attractive for homebuyers who don’t expect to stay in their house for the long haul or who think interest rates will be lower in the future. But since plans often change, and rates are virtually impossible to predict, it’s important to understand how ARM rates adjust.

Each ARM has an initial period and an adjustment period. The initial period is typically 3, 5, 7 or 10 years during which the rate is fixed. But after that, the rate will change according to its adjustment period. For example, a 5/1 ARM will remain fixed for five years, then adjust every year after that.

Two terms in an ARM’s fine print tell you how the new rate will be calculated: the index and the margin. The index is a market benchmark to which your rate is formally pegged. Many ARMs use the 12-month LIBOR index, but there are several others. Each ARM will name the index with which it is linked, and that index will fluctuate with market conditions.

The margin, on the other hand, is fixed and serves as an add-on to the index. So if an ARM’s margin is 3%, and the 12-month LIBOR index is 2.25% at adjustment time, the new rate would be 5.25% (2.25% index + 3% margin).

Two more ARM terms can also come into play. One is the rate adjustment cap, which limits how much the rate can move with any one adjustment. The other is the maximum rate, which specifies the very highest it can rise over the life of the loan.

Anyone considering an ARM will want to carefully compare different products according to index and margin rates, as well as adjustment caps and maximums, as digging into these details can help differentiate between otherwise similar-seeming ARMs.

What is a step-up or rising rate CD?

By Sabrina Karl

Certificates of deposit are generally pretty straightforward: You choose a term and the bank pays you a fixed interest rate as long as you keep your funds there until maturity.

But some banks will throw a specialty CD or two onto their menu. One is the step-up CD, and its name can sometimes confuse. So let’s dig into what step-up certificates are, and what they’re not.

Step-up and rising rate CDs are usually the same thing. Both pay pre-established interest rates that increase at intervals throughout the term. For instance, a five-year step-up CD may pay 0.5% in Year 1, then 1.0% in Year 2, and so forth until it pays 2.5% in Year 5.

That means your true earnings are a blended rate that averages the various tiers. In the example above, the CD would pay an actual rate of 1.5% over five years.

Of course, if you cash out early on a step-up CD, not only will you be hit with an early withdrawal fee, but you’ll miss out on the higher rates you would have earned in later years.

Shopper beware that there are also bump-up and raise-your-rate CDs. With these, you can choose to raise your CD’s APY to the bank’s current (presumably higher) rate, usually once or twice during the term.

Also note that some banks have begun interchanging these terms. So while the definitions above are traditionally true, you may see a CD marketed as a step-up when actually it’s a bump-up.

Step-up CDs are typically advertised with their highest rate highlighted, so be sure to read the fine print on what the blended rate will be. It’s likely you can earn more by shopping diligently among the fixed-rate certificates. In any case, be sure you understand exactly what it is you’re looking at.