When you are shopping for the best CD rates, you may have heard the term “brokerage CD.” What exactly is a brokerage CD, and how does it differ from a regular bank-issued CD?
It’s pretty simple: a brokerage CD is a certificate of deposit that you buy from a broker, rather than directly from a bank.
Why a Brokerage Certificate of Deposit?
Why would you choose to go through a broker? There are several advantages to buying from a broker rather than directly from a bank.
Sometimes, deposit brokers are able to negotiate a better interest rate with the bank because they are aggregating a certain number of depositors – in effect, they are bringing more business to the bank.
Plus, in addition to higher CD rates, deposit brokers may offer CDs with non-traditional features such as variable interest rates or no penalties for early withdrawal.
However, even if the brokered CD has the best CD rates, you should ask your broker a few questions and do some research before you sign on the dotted line. There are some complex investment and tax considerations you should fully understand before committing to a brokerage CD.
Steps to Take Before a Brokerage CD
First, you will want to know where the CD will be held. Unlike a traditional CD, this type of certificate of deposit may be held by a group of investors rather than a bank. If you are co-invested with several investors on a single CD, it might not even be held in your name. Ask your broker to give you the exact name of the CD you are investing in, and check to make sure your broker’s records reflect the fact that the brokerage is acting as an agent for you and the other investors in the CD. For instance, the documentation should say something like “Name of Brokerage as Custodian for X,Y and Z.”
Also, if your CD is held at a bank, make sure you know which bank it is, and whether it is one where you are already a depositor. Because FDIC insurance only covers $250,000 per depositor per bank, you may be in for a surprise in the event that your bank is holding more than $250,000 of your money and you didn’t know about it.
Beware of Early CD Withdrawal Penalties
Finally, make sure you understand any penalties for early withdrawal, and whether your CD has any call features. Deposit brokers may claim that you have no penalties for early withdrawal, but your CD may be structured in such a way that, if you share the CD with other investors, your broker must find another buyer for your share of the CD and may need to sell it at a discount, thereby losing part of your investment.
Brokerage CDs are complex financial products. Be sure to read the fine print and don’t be swayed by the best CD rates: do your research to make an informed decision.