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FDIC's Consumer News: Tips on Buying a Bank CD

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FDIC's Consumer News: Tips on Buying a Bank CD

The FDIC recently published its Spring 2012 Consumer News which provides consumer tips and useful reminders of federal regulations and protections. These tips are often on subjects that may not be that interesting to savers, but this time there are tips on CDs. There's one article which provides general tips for selecting the right CD. There's also an article on market-linked CDs.

General CD Buying Tips

Here are some excerpts from the tips that I think are most useful in the Buying a CD article:

Added Risks of Going Through a Broker

The first tip is to "make sure you are purchasing a “deposit” product issued by a federally insured institution." When you buy a CD directly from a bank or credit union, this is typically straightforward. If you're not sure about the bank, you can look them up using the FDIC's Bank Find tool. It becomes more complicated when you're dealing with a broker. There is also more risk as explained in the article:

If the broker fails to place your funds into a CD at an FDIC-insured bank, your money will not be insured by the FDIC

Make Sure All of Your CDs are FDIC Insured

As you might expect, the FDIC offers some tips to more sure your CD and all other funds a bank are insured:

If you have more than $250,000 on deposit at a FDIC-insured bank you can call the FDIC toll-free at 1-877-275-3342 and speak to a deposit insurance specialist who will help to make sure you are fully insured. You can also use the FDIC’s online deposit insurance estimator “EDIE” at www.fdic.gov to verify your deposit insurance coverage.

High-Rate CDs Advertised in Newspapers

The article provides a reminder of a common marketing ploy involving high-rate CDs advertized in newspapers:

A very high interest rate advertised on an FDIC-insured bank CD could be a scheme created when a finance company or an insurance agent adds a small bonus to the CD to lure people in the door and, sooner or later, tries to sell the customers uninsured, long-term investments that may not be in their best interest

The FDIC provided more details on this marketing ploy a couple of years ago, and I wrote about it in 2010.

Auto Renewal Issues

Another tip recommends CD holders review the auto-renew policies of their CDs. It says you should "check to see if the automatic renewal will be at the “old” interest rate or the current rate at the time of the renewal." I have never seen a CD that renews at the old interest rate. All that I've seen renew at the current rate which is often much lower than the old rate. This is especially the case if the old rate was from a CD special. There are other issues to consider when a CD matures such as the grace period and the procedure to close and receive the funds.

Early Redemption

The last tip from the FDIC is to "determine whether you can terminate the CD early." It specifically warns about market-linked CDs which typically do not allow for an early redemption. The article also should have mentioned the fact that some banks give themselves the right to refuse an early redemption.

The CD may sometimes be terminated early by the bank. This is the case for callable CDs. Here's what the FDIC says about callable CDs:

Also be aware that market-linked and other long-term, high-yield CDs typically have “call” features that give the bank the right to close the account early. A callable, fixed-rate CD could undermine your ability to lock in an attractive, long-term interest rate. Why? If interest rates fall, the issuing bank may decide to call the CD and give you back your money (plus accrued interest) because it can issue new CDs at the lower interest rates.

I have more tips for buying CDs in my post 10 Gotchas to Avoid for Bank CD Investors.

Market-Linked CDs

The second article provided some tips and warnings about market-linked certificates of deposit (also known as indexed or structured CDs). Below are the excerpts that I found most useful:

FDIC Insurance

The first tip from the article is to make sure the principal amount of the CD is guaranteed against loss:

to qualify for FDIC insurance coverage, the principal amount you invest must be guaranteed by the issuing bank. "If the principal is subject to loss — other than for an early withdrawal penalty — the product is not insured by the FDIC if the bank were to fail."

This appears to conflict with EverBank's explanation of its WorldCurrency CDs which can lose value due to currency fluctuations, but they are supposedly still FDIC insured. These are not market-linked CDs, but foreign currency CDs so that may be the reason for the discrepancy.

Update 5/22/2012: I emailed my contact at EverBank about this discrepancy, and here is the reply I received:

In general, the principal as denominated in the foreign currency is guaranteed by EverBank. If you put $1,000 euros into a CD, you will get 1,000 euros at the end of the term. And if EverBank fails, the FDIC will guarantee 1,000 euros. If the exchange rate changes between the time of opening and the time of maturity, that may effect the customer’s return if they convert back into dollars, but that conversion adjustment should not be interpreted as a loss of principal.

Cap on the Upside

One potential downside is that the market-linked CD may cap the upside:

“You may find that your share of any uptick in an index will be limited to a certain percentage and subject to a maximum cap,” said Meron Wondwosen, an FDIC Consumer Affairs Specialist. “For example, it’s possible for the market index to increase by 25 percent but your actual return on the CD may be only 10 percent.”

Tax on Phantom Income

Another downside is the potential to owe tax on "phantom income":

you may be required to include interest income in your taxable income each year that you receive a Form 1099-INT from the issuing bank, even though you were not paid interest during that year but will be paid the interest at the maturity of the CD.

May not Earn Any Interest

Some indexed CDs guarantee that depositors will earn interest, but some do not.

Some Market-Linked CDs are Callable

Some market-linked and other long-term, high-yield CDs have “call” features in their contract giving the bank — not the depositor — the right to close the account early without paying a penalty. The bank is most likely to exercise this option when interest rates fall, which means a callable CD would limit your ability to lock in an attractive interest rate for a long time.

More Risks If Bank Fails

With typical CDs, you are guaranteed to receive both the principal and the accrued interest if the bank should happen to fail before the CD matures. If it's a market-linked CD, you may not get back accrued interest:

If the bank has guaranteed that the principal will not go down in value, the FDIC will cover both the principal and any accrued interest, up to the federal insurance limit. But if interest is only credited at maturity, and if the bank were to fail before the CD matured, no interest would be insured because no interest had accrued.

Shopping Around?

Finally, the FDIC recommends people to shop around. I've found this to be difficult since banks rarely describe their market-linked CDs on their websites. EverBank is the only internet bank that I'm aware of that used to regularly offer this type of CD. However, it has been a while since EverBank has offered a market-linked CD. If you know of banks offering market-linked CDs, please leave a comment.

Other Tips in the FDIC Consumer News

In addition to CDs, the FDIC had an article on Ways to Minimize the Borrowing Costs for College and on auto loans.

The last article should also be useful for savers. It covers the steps to take if you think your bank has not treated you fairly.


  Tags: CD rates

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Comments
9 Comments.


Comment #2 by pearlbrown posted on
pearlbrown
You are right that they are not working for free.  Their bread and butter comes from the brokerage business and they offer access to CDs only as a convenience for their clients.  That convenience comes at a price, because the broker offers you a slightly lower rate than what you could get yourself.  Also, I think they negotiate slightly better rates on the volume of business placed. 

1
Comment #3 by Jason (anonymous) posted on
Jason
its interesting to read about USA bank structure, I read about http://banksavingsaccount.com.au  about australian banks,, its lot different

1
Comment #4 by Anonymous posted on
Anonymous
brokered cds are not at a slightly lower rate for the same bank.  They are at a lower rate, not slight.  You can look right now at vanguard or fidelity or schwab and you will see different, lower rates for the same cd at eg ally bank

5
Comment #5 by Paoli2 posted on
Paoli2
#4  You are right.  "Slightly" is being much nicer to them.  Over a year ago when I tested out the difference between them, it wasn't as bad as it is now.  I would not fool with them now unless I had to since there is such a big difference in even the longer terms like 5 yr CDs.

1
Comment #6 by ChrisCD posted on
ChrisCD
You are correct, the broker isn't working for free.  They are generally dealing with CDs that are part of a much larger Master CD and sold through participants that have access to DTC CDs.  The Master CD may be $10MM or even larger.  The brokers sell portions to their clients.  The spread between the real coupon and the rate you are offered is where they make their $.  Multiple parties are probably sharing the spread which is generally 20 to 30 Basis Points. So unless you are doing large CDs, they aren't making much.

On average the spread has been shrinking as rates have decreased.  Whether it makes sense or not is really dependent on whether the difference between what you can do on your own and what they can do for you is enough to compensate you for your time. 

Some banks don't even offer all of their rates through retail channels so sometimes you can find a better deal, but more often then not the retail rate is higher.  However, I know Goldman Sachs within the last six months had a long-term CD paying something like 3.00%.  It was only available through the brokered channel.

 

7
Comment #7 by Anonymous posted on
Anonymous
Ken,

re: EverBank's CD's you state:

These are not market-linked CDs, but foreign currency CDs so that may be the reason for the discrepancy.

Not clear.  What discrepancy?  Are these CD's FDIC-insured or not?  Based on the FDIC definition, they are not.  Can you clear this up for us?

1
Comment #8 by KenBDG posted on
KenBDG
@anonymous #7, I've emailed my EverBank contact about this discrepancy. I will let you know what EverBank says.

3
Comment #10 by KenBDG posted on
KenBDG
@anonymous #7, I've updated the post with the reply I received from EverBank.

3
Comment #11 by Anonymous (Stan) (anonymous) posted on
Anonymous (Stan)
Thanks Ken re: #8.

--Stan

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