What Is a Brokered Certificate of Deposit (CD)?

What Is a Brokered Certificate of Deposit (CD)?
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When looking at certificates of deposit, you'll find that brokered CDs stand out from the other available CD offerings. Rather than going to a bank directly to open your CD, you go through a broker who has already invested in CDs at various banks and can present you with options that can have more appealing terms than traditional bank CDs. Along with some benefits like higher returns and the option to sell the CD early, you can encounter some drawbacks like fees, potential losses and more complexity. So, read on to get a detailed guide about these CDs that can help with your investment decision.

Understanding Brokered Certificates of Deposit

When comparing brokered CDs to bank CDs, some similarities apply regarding how these accounts work and what features investors can expect. Brokered CDs still come with a set term that can range from months to a few decades, and investors usually get a fixed interest rate that can vary by factors such as how long the term is, which bank provides the CD and current market rates. Further, brokered CDs are meant to be held until the maturity date, although there's some more flexibility with these accounts.

The main differences are in how you obtain and use these accounts as you'll need to find a brokerage firm to purchase the brokered CDs through and will get to obtain accounts through multiple banks this way. How it works is that the brokerage will look for CDs that offer the best terms and purchase them – often of very high amounts – from various banks. They then sell portions to individual investors who usually pay an asset management fee. Brokerages can offer first-issue CDs along with those on the secondary market that other investors have sold before maturity.

During the term, you receive regular interest payments but don't benefit from compounding interest as with bank CDs. You can cash out your brokered CD upon maturity without a penalty, but you don't get the automatic rollover option like you would with bank CDs. If you need to get rid of the brokered CD early, you get the unique option to sell it on the secondary market to other investors. This can result in either a loss or gain, depending on the quality of the bank and prevailing interest rates at the time of sale.

Benefits of Choosing Brokered CDs

Choosing brokered CDs over bank CDs can offer some unique advantages that may fit your investment preferences, and you also get some advantages that all CDs share. Several of these include:

  • Higher interest rates than bank CDs: The concept of a broker buying CDs from multiple banks can mean they get more desirable terms, and these higher interest rates benefit you as an investor. Along with receiving regular interest payments that can be more attractive than those for bank CDs, you could possibly sell brokered CDs early and gain money when current interest rates aren't as attractive as what your CD offers.
  • Professional guidance: While you can ask for advice from financial representatives when you buy a bank CD, using a brokerage account also provides this benefit as you have financial advisors who have already researched CD rates for good deals and can suggest the best options for your financial situation. You can also get help with investment strategies and ask questions about legal issues around CDs when you work with a personal broker.
  • Increased liquidity: Except for no-penalty CDs, bank CDs generally don't offer liquidity unless you want to possibly pay a hefty fee to remove your money before the end of your term. Brokered CDs, however, come with the option to sell if you need out early, and this can work out better or worse for you financially, depending on whether you sell for a profit or loss.
  • Gains possible when selling: With bank CDs, you can't just sell the account, and if you withdraw early, you likely stand to lose significant interest already accrued. But when selling a brokered CD in a time when CD rates have dropped, you stand to gain money depending on what the buyer is willing to pay.
  • More attractive CD ladder option: You can use the CD ladder investment strategy for any kind of CD where you split your money into multiple CDs of varying terms with the goal of maximizing your return. However, it's more attractive to do this with brokered CDs since you get access to many banks in one place and can manage your numerous accounts more easily through the brokerage.
  • Wide selection of options: Compared to picking CDs from one bank, using a brokerage gives you many more choices when it comes to terms and interest rates. You can easily invest in CDs from many banks at once and keep track of all those accounts in one place.
  • FDIC coverage available: As long as you choose a reputable brokerage and check before agreeing to an investment, you can usually have Federal Deposit Insurance Corporation coverage for your brokered CD. This means that a CD with as much as $250,000 at a single bank should be covered if you're the sole owner. You can put the same amount at another insured bank in a CD and get the same protection.

Disadvantages of Choosing Brokered CDs

When considering this type of CD as an investor, know that many of the downsides relate to higher risk and costs. Several considerations include:

  • Extra fees: When you have brokered CDs, you can experience a few types of fees. One is an asset management fee for the brokerage to hold your CDs. You can also experience fees for buying and selling CDs on the secondary market; for example, you might pay $1 for each $1,000 bought or sold. So, you'll need to factor such fees into your buying and selling decisions.
  • Longer terms: You'll find that brokerages often have longer terms for their CDs. While this can look appealing for long-term investments, keep in mind, this means your money gets held up for that significant time unless you're willing to sell and pay transaction fees. In the meantime, you don't have the benefit of enjoying rising rates if they occur during the term, and if you need to sell in a time of lower rates, you can experience a loss doing so.
  • High initial investment: Similar to how you can get a higher yield for jumbo CDs with high deposit requirements but higher rates, brokered CDs can also require a significant investment that may make them less accessible depending on your financial situation. While you could find a brokered CD with just $1,000 required, others may require $10,000 or $25,000.
  • Limitations in liquidity: While you could sell your brokered CD, you don't get the option to simply cash out and pay an early withdrawal fee as with bank CDs. Instead, you'll need to look to the secondary market and hope that your CD is in demand and can be sold as soon as you need the money.
  • Possible scams and poor advice: With numerous brokerages and salespeople offering brokered CDs, it can be hard to know who is legitimate, so you need to do careful research. You might find a brokerage that mentions unusually high rates, but they could be a scam. At the same time, your broker may offer financial advice that is harmful or doesn't help you maximize your earnings.
  • Losses possible when selling: If you have a brokered CD with a lower interest rate than what's currently offered, you can experience losses that surpass what you would have paid for an early withdrawal fee for a regular bank CD. So, you have to time CD sales carefully.
  • Potential FDIC coverage issues: The issuing bank should provide FDIC coverage for your brokered CD, but you can run into problems if you don't do your research. For example, your broker may offer you investments from institutions without FDIC insurance, or you may accidentally go over the FDIC coverage limit for significant investments at a single bank that is FDIC-insured.
  • Call risk: Your brokered CD may feature callability where the issuer ends the term early, and you don't get to benefit from future interest on your investment. This can particularly hurt when you're left with only lower-yielding options.
  • Taxation: All CDs come with the downside of taxable interest since the Internal Revenue Service makes you report it as income on your income tax return.

Moving Forward with Brokered CDs

If you're an investor who likes the idea of having the ability to sell your CDs early, get better terms and easily choose and manage several accounts, then brokered CDs can work as long as you understand the added risk and potential to lose money if the account lacks FDIC coverage or needs to be sold for a loss. You can find these CDs through places like TD Ameritrade, E*TRADE, Fidelity and Charles Schwab and speak to an investment professional who can provide further guidance and help you get started.

Considering Alternative CD Accounts

When it comes to saving your money, you have plenty of bank CD options if brokered CDs don't sound right for you. Here are some of them to consider:

  • Traditional CDs: You can find traditional CDs from banks that may list no minimum deposit requirement and have shorter terms that allow you to cash out sooner. You also can always pay the early withdrawal penalty and won't have to worry about selling your CD on the secondary market. However, you may get a lower interest rate than a brokered CD offers.
  • Step-up CDs: This is similar to a traditional CD except that your interest rate changes in steps during the term. You'll see the bank's schedule before you open the account, and you'll usually see a lower rate to start out, with the steps increasing based on the market changes.
  • Jumbo CDs: Like brokered CDs, these can earn you a better rate than traditional CDs, but you'll probably see even larger initial deposit requirements of as much as $100,000. If you think you'll need an early withdrawal, consider that it could cost you years of interest if you open this kind of account.
  • Liquid CDs: Offering lower rates than the other options, these CDs offer the most liquidity. Usually, you need to wait a week but can remove all your cash for no penalty at all, versus selling on the secondary market and incurring fees and maybe losses.
  • Bump-up CDs: If you want flexibility in case interest rates go up during your CD's term, this type of account lets you request a rate change once, unlike a brokered CD that offers no such flexibility. However, you may not want to exercise this right, especially if rates get worse over time.
  • IRA CDs: Similar to a brokered CD in that you can hold many CDs in one account, this is designed specifically for long-term retirement savings. Keep in mind there are limits to how much you can invest annually, and IRA CDs have more complexities in terms of tax consequences if you need to take money out early.