Understanding Bank CD Rates

A Certificate of Deposit (CD) is a pre-fixed yield financial instrument used by banks in the US to accept deposits from US citizens. Understanding Bank CD rates is important for depositors to maximize the return on their investments in bank deposits. Investing a certain minimum sum of money in a bank deposit earns you a certain fixed rate of interest, for a fixed tenure.

Bank CD rates basically depend upon the state of the US economy and are an indicator of its health. The US Federal Reserve periodically fixes a limit on the prime lending rate (PLR) for banks in the US to lend money to people and the business community. The PLR fluctuates periodically based on the health of the US economy.

Banks in the US work under US Federal Reserve guidelines and the PLR cap. They earn money by collecting higher annualized per year (APY) interest rates on loans extended by them than on bank CD rates offered by them. This comparison is based on the same tenure and same initial date consideration for both loans and deposits.

What banks do is to fix the APY rate of interest they collect on loans on the PLR cap fixed by the US Federal Reserve. They are allowed a slight leeway in loan rates subject to the cap so you will find that different banks offer loans at slightly different interest rates for the same tenure loans. They also from time to time revise the loan and deposit rates based on periodic PLR revisions by the US Federal Reserve.

Banks always fix the CD rates a little lower than the loan rates to earn a profit in their business of offering loans and accepting deposits. Here too they are allowed a slight leeway so you will find that different banks offer you slightly different CD rates for same tenure deposits.

Some banks offer comparatively slightly higher CD rates for same tenure and same minimum deposit principals than others to gain an edge in attracting deposits from customers. By doing so they collect more money and so they are able to invest more money especially in corporate loans. Consequently they can potentially earn more profits.

The strategy of banks to offer more APY interest rates on higher tenure deposits is based on the flexibility that they get to use that money to invest in loans fetching them higher rate of interest. The longer the tenure for which you invest your money with banks, the higher the bank CD rates you can get. However, this also is subject to a cap that exists for 5-year and more tenure deposits.

Like all other people your capacity of investing in bank deposits is based on your household income, expenses, and the time horizon of your needs. So, you will find that different people get attracted towards offerings of differing bank CD rates and tenures from various banks. This is because primarily their needs are all different.