Broker vs. Bank CDs: Make Sure You Know What You're Getting

Buying a certificate of deposit seems like one of the safest financial transactions you can make. But with interest rates on CDs bumping along below 1 percent, it's tempting to hire someone else -- a CD broker -- to do the legwork and shop around for an above-market rate.

If you decide to go that route, you must first do your due diligence.

The Federal Deposit Insurance Corporation, or FDIC, warns that CD brokers are not always legitimate, and CDs purchased through a broker may not offer the same protection as those you buy directly from a bank.

Shop Smart

CDs are typically sold for terms ranging from three months to five years, offer a fixed or variable interest rate, and, if purchased from an FDIC-insured bank, are protected with FDIC insurance of up to at least $250,000 per depositor.

The FDIC offers several suggestions to help consumers protect themselves against a CD con.

Check out the broker's reputation. Anyone can claim to be a CD broker, but you're better off working with someone you already know, such as a financial planner or a stockbroker. If you're intrigued by an offer from an unknown broker, research the broker's credentials and licenses by checking with the local Better Business Bureau or FINRA (Financial Industry Regulatory Authority) or your state's consumer protection office.

According to the FDIC, multiple complaints have been made regarding consumers wiring money to someone who claims to be a CD broker but then disappears with the money. Another issue is that your funds may not be invested at an FDIC-insured financial institution and therefore are at risk should that institution fail.

Be skeptical of high interest rates. While the idea of using a CD broker is to find a better interest rate on your savings, some unscrupulous brokers lure customers by advertising above-market rates on CDs and then attempt a bait-and-switch trick to get you to invest in riskier products.

For instance, the FDIC recently had a case in which a high-rate CD was offered by a foreign bank and therefore wasn't FDIC-insured. The broker's marketing materials included information about an FDIC-insured bank, but that bank was only involved in wiring funds to the foreign bank. You may be willing to take the risk of buying a CD from a foreign bank, but you should be fully informed when you do it.

Check for FDIC insurance. This takes a couple of simple steps. First, find out where your funds will be deposited, and then go to the FDIC BankFind site to verify the insurance coverage for that bank.

Next, confirm that the deposit account records reflect the broker's role as an agent for its clients so that each client gets "pass-through" deposit insurance up to $250,000. If you have other accounts at that bank, check to make sure your entire deposits there don't exceed $250,000, because your deposit insurance is limited to that amount.

Find out how to get your money in an emergency. With a traditional CD, you typically pay a penalty if you have to withdraw your funds before the CD matures. Brokered CDs, which can have maturity dates of 10 or even 20 years, are often sold without an early withdrawal option. In that case, your only option typically is to sell your CD to another investor at the current interest rate. You may have to sell at a loss if interest rates have risen, because an investor is unlikely to buy your CD investment at 3 percent if CD rates have gone up to 5 percent or higher. (On the other hand, if interest rates have fallen, you could end up making a profit.)

Note that your deposit insurance could be delayed. If you end up with a CD from an FDIC-insured bank that fails, the deposit insurance benefit is paid to the broker, who then distributes the funds to investors. If you bought a traditional CD from a bank that fails, your deposit insurance benefit would arrive more quickly because it does not have to go through the broker first.

While there are legitimate CD brokers who can help you earn more interest on your savings, you should take the time to check out the reputation of the broker and the financial institution where your money will be deposited. If you have a complaint about a CD broker, contact FINRA or, if the complaint is about a CD sold by an investment firm, contact the SEC.

Michele Lerner is a contributing writer to The Motley Fool.