What is a brokered CD and who needs one? (2023)

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Brokered CDs offer higher interest rates than bank CDs, but with far less liquidity. Are they right for you?

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What is a brokered CD and who needs one? (1)

With interest rates on the rise, you may be hearing about certain types of investments for the first time. One of these is a brokered CD, which is offered by a brokerage firm rather than a bank. These CDs arefederally insured and usually pay higher interest than bank CDs, but they aren’t liquid. If you’re considering a brokered CD, read on so that you understand how they work and whether the risks offset the potential benefits to you.

What is a brokered CD?

A brokered CD is a federally insured bank CD that is sold through a brokerage firm. These are less liquid than a traditional CD, but they tend to pay higher interest. Banks offer brokered CDs to raise money quickly, without spending on branch infrastructure or consumer marketing.

Rising interest rates are making CDs look more attractive. Brokered CDs offer the potential for even greater returns, but they are not always a good investment. That’s because they are not as liquid as traditional CDs. The only way to get money out of a brokered CD before maturity is to sell it; there may not be a buyer, and the price may be less than the amount you invested.

How does a brokered CD work?

With a brokered CD, the brokerage firm purchases a large CD from a bank and distributes shares in it. Account holders buy shares in the CD from the broker, then receive interest and principal in their brokerage account when the term is up. Brokered CDs may be available in a greater array of maturities than many banks offer.

Generally, brokered CDs pay simple interest rather than compounded interest. Comparing the yields on different CDs, rather than the rates, will ensure that you are making a fair comparison. After all, a lower rate will turn into a higher yield when compounding is considered.

Why are brokered CD rates higher? Well, unlike a traditional CD, you can’t withdraw money from a brokered CD. Instead, account holders who want their money early need to sell their CD shares. There’s a fee for this, and there’s a chance that there won’t be a buyer — or that the buyer will pay less than the principal value. A brokered CD’s value will fluctuate with interest rates, although you will receive the full principal amount when it matures.

Furthermore, the broker provides customer service, not the bank. This saves the bank some money, which shows up in the higher return.

Pros and cons of brokered CDs

For savers, there’s only one pro of a brokered CD over abank CD, but it’s a big one: the higher yield. For many buyers, it more than balances the relative lack of liquidity. The relative lack of liquidity is the main con. Savers who don’t already have a relationship with a broker may find that the process of opening an account is a hassle, especially if they have a relatively small amount of money to invest. Some brokers charge a fee for opening a CD account, too.

Because the lack of liquidity is a big drawback, a brokered CD is not appropriate for emergency funds or other money that you may need to access before the maturity date.

Different types of CDs

The banking industry offers a range of CDs so that banks and savers can meet their needs for liquidity and return. These include:

  • Traditional Bank CD: A traditional bank CD offers a fixed interest rate and a fixed maturity date. In most cases, account holders who withdraw money before maturity must pay back some interest earned as a penalty. These are insured by the FDIC or NCUA up to $250,000.

  • Brokered CD: Banks arrange with a broker to sell CDs at higher yields than are available with most banks. Account holders cannot withdraw money before maturity, but they can resell their CD to another investor. Many brokerage firms charge a fee for this service. Brokered CDs are insured for up to $250,000 through the FDIC.

  • Negotiable CD: A negotiable CD generally is an uninsured CD with a high balance. These tend to have higher yields than other forms of CDs and are offered by banks directly or through a brokerage firm. Some money market mutual funds invest in short-term negotiable CDs.

How to buy a brokered CD

As the name implies, brokered CDs are sold through a broker. Many large mutual fund companies offer brokerage services, so you may already have a relationship with a firm that can help you purchase a brokered CD. If you do, simply go to the broker’s web site and follow the instructions. Some brokers allow you to buy a brokered CD at no charge.

If you need to open a brokerage account, you will have to research the fees, capabilities, and account minimums. This adds an additional step to the process.

High-yield savings account vs. brokered CD

A brokered CD is one of many places where savers can put money. A high-yield savings account is another alternative. This is a federally insured savings account with a relatively high rate of interest and liquidity on demand. However, it often pays a lower rate of return than a brokered CD.

Because of the ready liquidity, a high-yield savings account is a place for money that you may need at any time, such as an emergency fund. It is also a good choice when CD rates are very low; by keeping your money in a liquid account, you can easily move it into a brokered CD when rates improve.

Editorial Disclosure: All articles are prepared by editorial staff and contributors. Opinions expressed therein are solely those of the editorial team and have not been reviewed or approved by any advertiser. The information, including rates and fees, presented in this article is accurate as of the date of the publish. Check the lender’s website for the most current information.

This article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as the Home and Financial Services Editor for the Hearst E-Commerce team. Email her at lauren.williamson@hearst.com.

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