Do Certificates of Deposit (CDs) Help Build Credit?

Investing News

A certificate of deposit (CD) is a financial product that is similar to a typical savings account and is offered by banks, credit unions, and other financial institutions. The Federal Deposit Insurance Corp. (FDIC) and the National Credit Union Association (NCUA) insure CDs for up to $250,000, making these types of investments practically risk-free.

Unlike normal savings accounts, CDs have a fixed term of usually one, three, six, or 12 months, though some may have up to a 10-year term. Also, CDs typically have a fixed interest rate.

Key Takeaways

  • A certificate of deposit (CD) is a long-term deposit instrument that pays a guaranteed fixed interest rate through to maturity.
  • CDs are federally insured up to the $250,000 Federal Deposit Insurance Corp. (FDIC) limit per banking institution.
  • Loans taken against a CD can be reported to credit agencies, which can help savers build credit scores.

Certificates of Deposit (CDs)

A certificate of deposit (CD) is a product offered by banks and credit unions that offers an interest rate premium. The account holder agrees to leave a lump-sum deposit with the institution for a predetermined period of time.

Almost all consumer financial institutions offer CDs, although it’s up to each bank which CD terms it wants to offer and what the rate will be. The banks also determine penalties that apply to early withdrawals.

Unlike most other investments, CDs offer fixed, safe—and generally federally insured—interest rates that can often be higher than the rates paid by many savings accounts. And CD rates are generally higher if you’re willing to deposit your money for longer.

As a result of the Federal Reserve’s rate hikes since 2017, CDs have become a more attractive option for savers who want to earn more than most savings, checking, or money market accounts pay, but without taking on the risk or volatility of the market.

Using a CD to Build Credit

Since CDs are fixed-term deposits that an investor gives to a bank for a fixed rate of return, an investor can use CDs to build or strengthen their credit history. Minimum investments for CDs vary by institution, but they are commonly $1,000. The institution issuing the CD typically allows the investor to borrow up to 95% of the investment’s value shortly after opening the account, to be used as collateral in case of default.

Banks or credit unions generally, but not always, report this type of loan to the credit bureaus as a secured installment loan. So, confirm with the institution that they are indeed reporting your payments. Making punctual payments on this loan increases a person’s credit score over time, and the process can be repeated indefinitely.

CDs are completely secured, such that the institution involved usually approves this type of loan. For this reason, they are often a good option for someone trying to build or repair a poor credit score.

What are the Main Types of Certificates of Deposit?

There are several types of certificates of deposit (CDs). They include high-yield CDs, which offer interest rates that are higher than average, jumbo CDs, which require larger minimum balances and offer higher rates, and no-penalty CDs that provide easier access to your funds.

What is the Minimum Balance for a Certificate of Deposit?

The minimum balance for a CD can range from about $500 to $2,000, depending on the financial institution and type of CD. Jumbo CDs generally require a much larger deposit, such as $100,000. Some CDs have no minimum deposit requirement.

Are Certificates of Deposit (CDs) a Good Place for Savings?

A certificate of deposit (CD) is an investment, not a transactional account for savings. If you need to withdraw the money from your CD before it reaches maturity, you will typically be penalized.

How do I Open a CD Account?

You can open a CD through banks and credit unions online or in person. First, you choose a CD type and term and then determine how you will receive interest. You’ll choose a financial institution, open the account, and then fund the account. You can also invest in CDs through brokerage firms.

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