What Is a Jumbo Certificate of Deposit (CD)?
A jumbo certificate of deposit is a CD that requires a higher minimum balance obligation than that required by traditional CDs. In return, the jumbo CD pays a higher rate of interest. A CD is a type of savings account that pays fixed or variable interest in exchange for depositors leaving their funds in the account until a specified date of maturity.
- A jumbo CD usually has 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.
- Jumbo CDs pay investors a fixed rate of interest, helping to stabilize returns in an investment portfolio by partly offsetting market risk.
Understanding Jumbo CDs
Traditional CDs typically offer a higher rate of return than do standard savings accounts or interest-bearing checking accounts. In this same vein, the jumbo CD will pay an even higher rate than is offered by traditional CDs. Jumbos receive a higher rate because they require a larger minimum investment than the standard CD. Most jumbo CDs start at $100,000, but some financial institutions offering them may have a few products with lower entry points.
Jumbo CDs are considered risk-free investments, as 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).
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. A one-year jumbo CD that pays 1.5% interest, for example, 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 and five years. And the longer the term, 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.
The amount up to which the FDIC insures CDs.
Advantages of 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, as some issuers have tenures 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. These jumbo CDs are instruments for treasury management of large corporations and money market instruments for large investors.
Other than being 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, which 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, CDs held in retirement accounts cannot be pledged as collateral for loans.
Jumbo CDs can be used as collateral for loans.
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. Nevertheless, the differences between those returns have narrowed in recent years, making a jumbo CD a less-compelling investment.
Jumbo CDs don’t typically keep up with inflation. If the inflation rate in the economy is 2%, for example, 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.
Should the holder need these funds before the jumbo CD matures, withdrawing them would result in a financial penalty, which could be a fee assessed by the bank for the loss of 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 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 they could have had if these funds had been available to invest elsewhere.
Reinvestment rate risk
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 other products, investors must weigh the pros and cons to ensure they don’t wind up with a lower return in the long term.
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.
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, as 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.
Examples of Jumbo CDs
Veridian Credit Union, founded in Waterloo, Iowa, in 1934, offers many types of CDs, including jumbo CDs. Examples of the jumbo rate as of Jan. 23, 2023, include:
- A nine-month jumbo CD with a minimum $100,000 deposit pays 4.20%
- An 15-month jumbo CD with a minimum $100,000 deposit pays 4.50%
Please note: The interest rates being offered can change at any time for new CDs and might be different depending on the state in which the depositor is located.
What Is the Shortest Term for a Jumbo CD?
Jumbo CD terms can be as short as a few days, but these extremely short terms are hard to find. More commonly, three months is the minimum term for a jumbo CD.
Do Jumbo CDs Earn a Higher Interest Rate Than a Normal CD?
Since jumbo CDs require a much higher minimum deposit, banks and credit unions typically reward savers with higher interest rates than for smaller accounts. Longer terms also earn higher interest rates. Those higher rates are incentive to reduce the liquidity of your savings.
How Much of my Jumbo CD Is FDIC or NCUA-insured?
The FDIC or NCUA insures up the first $250,000 in each account at an affiliated bank or credit union.
The Bottom Line
Jumbo CDs are a very safe place to hold money. Banks are willing to offer attractive interest rates for savers in exchange for fixed terms. While jumbo CDs are safe, they may not be the best place to earn money in a volatile interest environment. If interest rates are rising and you're locked into a long-term CD, you may miss out on the opportunity to invest at a higher rate. Consider your term length carefully before making a decision.