What it means
A certificate of deposit, or CD, pays a fixed rate if you leave your money untouched until the end of its term, which might be three months, one year or five years. Most banks publish a standard rate, but from time to time they advertise a higher promotional rate on one or two terms.
The bank does this when it needs more funding, for example to support new lending, and it would rather pay a higher rate to savers than borrow elsewhere. Promotional rates often come with strings.
The offer may apply only to customers who have not held an account with the bank before, may require a minimum deposit such as $10,000, or may be limited to one particular term. Some banks also require you to open a linked current account or set up regular deposits to qualify.
The most important detail is what happens at maturity. Many CDs renew automatically into a new CD at whatever the standard rate is at that time, which may be far below the promotional rate you originally signed up for.
Savers who miss the short window after maturity can find their money locked away again at a poor rate. You should also understand early withdrawal penalties.
If you take your money out before the term ends, the bank usually deducts a number of months of interest, which can wipe out the benefit of the higher rate. A promotional rate is only a good deal if you are confident you will not need the money before the end of the term.
Finally, compare using the annual percentage yield (APY, the real yearly return after compounding is included) and not just the headline rate. Check that the deposits are covered by the local deposit insurance scheme up to its limit, because the safety of the bank matters as much as the rate it offers.
In practice
Real-world examples.
Example
A retired teacher receives a $50,000 lump sum and puts it into a 12-month promotional CD at 5.0%. At the end of the year she earns $2,500, which is $750 more than the $1,750 she would have earned at a standard 3.5%.
Example
A small manufacturing company has $200,000 of spare cash it will not need for nine months. Its finance manager picks a nine-month bonus CD that pays more than the usual money market account, and sets a calendar reminder to move the money before the CD auto-renews.
Example
A young couple saving for a house deposit sees a bonus rate on a two-year CD. They decide against it because they might buy a home within 18 months and the early withdrawal penalty would reduce their return.
Formula
Calculation
For a CD that pays interest once a year, the interest earned is:
Interest = Deposit x APY x Term in years
The benefit of a promotion is the difference from the standard rate:
Extra interest = Deposit x (Promotional APY - Standard APY) x Term in years
Suppose you deposit $20,000 for one year. The promotional rate is 5.0% and the standard rate is 3.5%.
Promotional interest = $20,000 x 0.050 x 1 = $1,000.
Standard interest = $20,000 x 0.035 x 1 = $700.
Extra interest = $1,000 - $700 = $300.
If an early withdrawal penalty of three months of interest applied, the penalty on the promotional CD would be $1,000 / 12 x 3 = $250, which would take away most of the extra $300.Case study
Seen in the real world.
Lakeview Savings is an illustrative, fictional community bank that needed to raise $20,000,000 of new deposits before the end of the quarter to fund mortgage lending. It launched a six-month promotional CD paying 1.2 percentage points above its standard rate for new customers.
The bank attracted $24,000,000 in two months, and its funding costs were still lower than if it had borrowed the money from other banks. However, it noticed that many customers did not renew when the CDs matured, because they moved the money to the next best offer.
The treasury team learned to contact customers 30 days before maturity with a retention rate. The illustrative lesson is that promotional rates are a tool for buying deposits, and both the bank and the saver should plan for what happens at the end.
Watch out
Common mistakes.
- Focusing only on the headline rate and overlooking the minimum deposit, new-customer rule or limited term that determine whether you qualify.
- Letting the CD renew automatically at a much lower standard rate after the promotion ends.
- Locking money into a long promotional CD that may be needed sooner, then losing months of interest to the early withdrawal penalty.
Questions
People also ask.
Is a promotional CD rate guaranteed for the whole term?
Normally yes, once you open the CD the rate is fixed for the term, but the promotional offer itself may end before you apply.
Is my money safe in a promotional CD?
It is protected by the deposit insurance scheme of your country up to its limit if the bank is a member, so check the limit and spread large sums across institutions where needed.
How do I compare a promotional CD with other savings options?
Compare the APY, the penalty for early access and the fees, and consider whether a savings account or government bond would suit your need for access better.
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