What Is a Jumbo CD?

A jumbo CD is a certificate of deposit (CD) that requires a higher minimum balance obligation than that needed by traditional certificates of deposit. In return, the jumbo CD pays a higher rate of interest return. Certificates of deposit are a type of savings account that pays fixed-interest in exchange for depositors leaving their funds in the account until a specified date of maturity.

Jumbo CDs Explained

Traditional certificates of deposit typically offer a higher rate of return (RoR) than do standard savings accounts or interest-bearing checking accounts. In this same vein, the jumbo CD will pay an even higher rate than traditional CDs receive. Jumbos receive a higher rate because they require a larger minimum investment than the standard CD. Most jumbo CDs start at $100,000, but the financial institution offering the product may have some products that have lower entry points.

Jumbo CDs are considered risk-free investments since they're insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC). Credit Unions also market jumbo CDs, and these funds find protection under the National Credit Union Administration (NCUA).

Key Takeaways

  • A jumbo CD is a certificate of deposit (CD) with a minimum balance requirement of $100,000.
  • Although Jumbo CDs have higher minimum balance requirements than traditional CDs, in return they pay a higher interest rate than conventional CDs.
  • Jumbo CDs pay investors a fixed-rate of interest helping to stabilize returns in an investment portfolio by partly offsetting market risk.
  • Jumbo CDs can be used as collateral for loans.

Income from Jumbo CDs

Investors receive the premium—based on the fixed-interest rate—as compensation for not having access to their money over the life of the account. For example, a one-year jumbo CD that pays 1.5% interest may require that the funds remain locked up in the account for one year. Jumbo CDs can have term lengths as short as a few days or as long as a decade. However, the standard range is between three months to five years. Also, the longer the term length, the higher the interest rate returned on the funds invested.

Upon maturity of the CD, the financial institution returns the investor's principal. Early withdrawals may be possible, depending on the terms of the product purchased. However, the investor will pay a penalty for early termination of the contract.

How Investors Utilize Jumbo CDs

Large institutional investors are the typical customer for jumbo CDs. These large institutions include banks, some large corporations, and pension funds. Primarily, this is due to the high minimum balance requirements. These customers use jumbo CDs as a temporary investment vehicle since some issuers have tenors for as little as seven days. The short-term maturities allow institutional investors and companies to earn interest on idle money for short periods before rolling the funds into other ventures.

Other than getting paid to park their funds in these products, large investors use them as instruments to reduce their portfolio's market risk exposure. Market risk arises when the prices in the stock market fluctuate over time. As a result, stock portfolios can earn high returns, but they can also incur large losses. The steady interest paid on jumbo CDs helps offset and reduce the risk of negative returns that can happen from holding stocks.

A business seeking a loan or other type of financing from a bank can pledge its jumbo CD as collateral. Collateral is an asset held by a lender as security for a loan in the event the borrower falls behind or defaults on the loan payments. If the borrower defaults on the timely submission of payments, the lender can seize the collateral to recoup any losses. However, certificates of deposit held in retirement accounts cannot be pledged as collateral for loans.

Risks and Disadvantages of Jumbo CDs

Although jumbo CDs have positive aspects of higher rates and FDIC protection, there are disadvantages to investing in them. Historically, jumbo CDs have paid a much higher rate than traditional CDs and savings accounts. However, the differences between those returns have narrowed in recent years making a jumbo CD a less-compelling investment.

Inflation Risk

Jumbo CDs don’t typically keep up with inflation—known as inflationary risk. Inflation is a measure of the pace of rising prices in the economy. For example, if the inflation rate in the economy is 2%, and the interest rate on the CD is 2.5%, the investor is only earning 0.5% in real terms. To make an investment in a jumbo CD worthwhile, investors would need to lock in their funds for longer terms resulting in a higher rate.

Early-Withdrawal Penalties

Should the holder need these funds before the Jumbo CD matures, withdrawing would result in a penalty charged. The penalty can be a fee assessed by the bank, or the investor might lose the interest earned to date. Each bank will have specific rules and guidelines for early withdrawals. If it's likely that the funds might be needed before the CD's maturity, investors might be better off investing the funds in an account that doesn't have withdrawal restrictions such as a high-interest savings account.

Interest Rate Risk

Another worry for jumbo CD investors is interest rate risk. This risk comes when current market interest rates rise above the one offered by the jumbo CD. If interest rates rise while investors are holding a Jumbo CD, they miss out on the higher rates should these funds be free to invest elsewhere.

Conversely, if interest rates fall during the holding period, at maturity, the investor may not be able to reinvest the funds at a rate comparable to the CD. This hazard is known as reinvestment risk. Although jumbo CDs pay a higher rate at the onset as compared to the other products, investors must weigh the pros and cons to ensure they don't wind up with a lower return in the long term.

Pros

  • Jumbo CDs offer a steady rate of interest for the length of the holding term.

  • Jumbo CDs typically pay a higher interest rate than do traditional CDs or savings accounts.

  • The steady interest paid on Jumbo CDs can partly offset the portfolio's market risk of negative returns from holding stocks.

  • Jumbo CDs carry a guarantee of up to $250,000 per account by the FDIC or the NCUA.

Cons

  • Jumbo CDs pay a lower return than many other fixed-rate investments such as bonds.

  • In a rising market interest rate environment, jumbo CDs face interest rate risk since investors might hold a CD paying a lower rate.

  • Jumbo CDs don’t typically keep up with inflation meaning prices could rise at a faster rate than the CD's rate of return.

  • Investors cannot access their funds in Jumbo CDs before maturity without incurring an early-withdrawal penalty.

  • Jumbo CDs can have high minimum balance requirements.

Real World Example of a Jumbo CD

Wells Fargo Bank (WFC) is a consumer bank in the U.S. that offers many types of CDs including jumbo CDs. Examples of the jumbo rate as of April 13, 2019, includes:

  • A six-month jumbo CD with a minimum $100,000 deposit pays 1.15%.
  • A one-year jumbo CD with a minimum $100,000 deposit pays 1.25%.

Please note that the interest rates being offered by the bank can change anytime for new CDs and might be different depending on the state in which the depositor is located.