The interest rate set by the Federal Reserve is the highest it’s been since 2007. We are now seeing that affect the terms of some savings accounts offered by banks. Case in point: certificates of deposit, or CDs.
Some banks are offering about 5% for consumers to put their money in a one-year CD. But with the recent low-interest rate environment, banks may have to explain to their customers what CDs are in the first place.
University of Chicago economist Damon Jones was in college when he learned what a CD was.
“But I didn’t have any money, so I couldn’t really act on it,” he joked.
I was a teenager also with no money. And honestly, I thought a CD was a thing used for music, but in the financial world, “it is easier to explain a CD than some other investments because it’s just a percentage rate,” Jones said.
Banks offer to keep your money for a set period of time in a CD for usually six months to five years. The interest rate that each bank offers depends on how much that bank needs people’s money.
“The more they need it, the more they’ll probably pay for it,” said Merrill J. Reynolds, a banking industry consultant and faculty member at Southern Methodist University.
“When banks get all this cash in, the idea is to make money on that cash,” he said. “The easiest way to make money on that cash is to turn around and lend it out.”
So, if a person agrees to put their money into a CD for one year with an interest rate of 5%, that same bank might turn around and lend someone else the money to buy a house at a higher interest rate — maybe around 6.5%.
That difference is “called the spread,” Reynolds said. And rates offered for CDs vary a lot by institution.
“The largest U.S. banks, they’re not really playing the game as much as some of the smaller regionals,” said Herman Chan who researches regional banks as a senior equity analyst at Bloomberg Intelligence. “Really, the fact is that the largest banks are really awash in deposits.”
CDs offer all banks a kind of stability, according to financial risk consultant Mayra Rodriguez Valladares.
“They want more people and certificates of deposits, because then individuals are a lot less likely to withdraw their money,” she said.
Withdraw their money early, that is, “because that usually comes with a penalty,” Valladares explained.
According to the Federal Reserve, the amount invested in large CDs — specifically, with accounts holding $100,000 or more — had gone up nearly 44% in the past year.