Certificates of Deposit
When you purchase a certificate of deposit you sign a time deposit contract and agree to leave you deposited funds at the bank or credit union for a specific period of time. In return, the financial institution issuing the CD agrees to pay you a fixed rate of interest. Your CD matures at the end of the contract, and at that point you can make withdrawals or additions during a 7- to 10-day grace period. When the grace period ends, any remaining funds roll over into a new CD term.
Banks use money held in CDs to fund loans. Banks with large deposit bases can fund more loans, and therefore banks offer high interest rates on jumbo CDs in order to attract more deposit money. However, banks also fund loans with money borrowed from the Federal Reserve. When interest rates are low, banks can borrow money inexpensively from the Reserve and do not have to rely on CD money to fund loans. Consequently, banks only offer good rates on jumbo CDs if federal borrowing rates are high.
The Federal Deposit Insurance Corporation insures funds held in bank deposit accounts up to $250,000 per person per bank. Funds held at credit unions are insured to the same level by the National Credit Union Administration. Prior to 2008, the FDIC only insured deposits up to $100,000, which meant that earnings on jumbo CDs were not protected. Therefore, in the past, jumbo CD holders were exposing themselves to some risk in the pursuit of higher returns.
Some jumbo CDs take the form of brokerage CDs. These are CDs that banks sell to investment firms. CDs held in brokerage accounts, unlike other securities, are protected by FDIC coverage. Jumbo brokerage CDs typically have term times of just 6 months and are nonrenewable, which means you get your money back when the CD term ends. Some jumbo brokerage CDs are also callable, which means the issuing bank can cancel the CD and give you a return of premium before the CD term ends.