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What Is a Certificate of Deposit (CD)?

Certificates of deposit (CDs) offer savers a way to earn a higher interest rate on your savings in exchange for agreeing to lock up your money for a fixed period of time — while still keeping your funds safe thanks to the magic of FDIC insurance

That makes CDs fantastic for saving when you have a specific goal and timeline to save for. For example, a CD can be a good choice if you know you want to set money aside for a vacation that you’ll go on in six months.

But CDs have downsides too. Before you decide whether a CD is the right savings tool for you, learn about the basics of how CDs work and how they compare to other options.

What Is a Certificate of Deposit (CD)?

A certificate of deposit is a special type of savings account that holds a sum of cash for a set period of time. The bank holding the funds pays interest on the balance of the account.

Once the CD’s term ends, the CD matures and the holder of the account receives the amount they placed in the account, plus accrued interest. If the CD holder takes money out of the CD before it matures, they typically have to pay a penalty.

In general, CDs offer higher interest rates than savings accounts to compensate for the restrictions they place on the account holder’s access to the money. Like other bank accounts, they are protected by the Federal Deposit Insurance Corporation, making them a safe option for people who want to save money.

How CDs Work

When you want to open a CD, you go to your bank or credit union. Most financial institutions let you open CD accounts online. A few are more old-fashioned and require in-person opening.

You choose how much you want to deposit and how long you want to keep the money in the account. Then, you make the deposit and wait. Once your chosen period elapses, you get your deposit back, plus interest.

There are four important factors to consider when looking at CDs.

Initial Deposit

Many banks have a minimum initial deposit requirement, such as $100, $500, or $1,000. You need to make sure that you have enough money to open the account.

Assuming you have enough to reach the minimum deposit, you’ll have to decide exactly how much you wish to place in the account. The more you put in, the more interest you’ll earn. However, remember that your access to your deposit will be limited during the life of the CD.

Maturity Date

When you open a CD, you’ll also select a term of maturity date for the account. Once the maturity date arrives, the bank will return the money to you, plus interest. The length of time between opening the account and the maturity date is called the term.

The longer the term of a CD, the higher its interest rate tends to be. Given that CDs are mostly appealing because of their higher interest rates compared to savings accounts, this makes longer terms tempting to savers. 

However, the early withdrawal penalties charged for taking money from a CD before it matures typically increase as you choose longer CD terms.

Also, keep in mind that most CDs have a fixed interest rate. If you choose a maturity date that is far into the future, you’ll be locked into that interest rate. That can be a good thing if market rates fall, or a bad thing if rates rise. 

Those market rates can change based on many factors, including how the Federal Reserve adjusts its benchmark rate for interbank loans, known as the Federal Funds rate. In general, rates fall during economic slowdowns and recessions. They tend to rise when the economy is hot or inflation spikes. 

Interest Rates

Banks will advertise the interest rates, often as annual percentage yields (APYs) that they offer on CDs. The higher the interest CD’s rate, the more interest you’ll earn.

When you shop around to find the best bank to work with for your CD, consider the CD rates offered by each financial institution. You’ll generally want to find the one that offers the highest interest rates.

Early Withdrawal Penalties

A CD account offers higher interest rates than savings accounts because you promise to keep your money in the account for a set period of time. In exchange for giving up liquidity, banks compensate you with larger interest payments.

In most cases, if you take money out of a CD before it matures, the bank will charge a penalty. The fee is usually equivalent to the amount of interest you’d earn over a number of days or months. For example, an early withdrawal penalty might be equal to six months’ interest.

While opening a CD when you might need quick access to the cash isn’t a great idea, it is still important to look at the penalty that the bank charges, just in case your situation changes.

Types of CDs

The basic concept of a CD is simple: deposit money, wait, and receive interest. But some banks offer more complicated types of CDs that add additional features.

  • Traditional CDs. These are basic CDs that work as described above. They usually have terms ranging from a year to five years.
  • Short-Term CDs. These are also basic CDs, but usually have very short terms, ranging from a month to a year.
  • Brokered CDs. Instead of getting these CDs from a bank, you can get these CDs from brokerage companies. They may have higher levels of risk than a bank CD, but compensate with more interest.
  • Jumbo CDs. These CDs require significantly higher minimum deposits than most. Often, the minimum deposit can be $100,000 or more. However, they may also come with higher interest rates.
  • Callable CDs. Your CD’s paperwork might note that your bank or financial institution can choose to close your CD early once a specific “callable date” arrives. If the bank does call your CD, it closes the account and pays you the full term’s interest.
  • No-Penalty CDs. These CDs have no early withdrawal penalty, meaning you don’t have to worry about the fixed term that is the main drawback of opening a CD. However, a no-penalty CD will usually have a lower rate and shorter term than a new CD of another type.
  • Step-Up CDs. A step-up CD gives the account holder the option to increase or step-up the rate on the account at specific intervals or a set number of times. This reduces the risk of opening a CD with a fixed rate only for market rates to increase. However, they usually start with lower interest rates and are not particularly common.

What Happens When a CD Matures

When a CD matures, you get an opportunity to withdraw your money from the account, deposit more money, or make other changes.

The process varies slightly depending on the bank you’re working with but should follow a similar pattern no matter where your money is held.

First, the bank sends you a notification that your CD’s maturity date is nearing. You’ll usually get the message a few weeks to a month in advance. When you get notified, you should start thinking about what you want to do with the account.

Once the maturity date arrives, you’ll have the chance to make changes to the account. Banks will give you a grace period, usually a week or two. During the grace period, you can withdraw some or all of the money in the CD, add money to the CD, or make other adjustments without paying an early withdrawal penalty. If you withdraw all the money in the CD, the bank closes it, and you’ll need to open a new CD account if you want one in the future.

After the grace period ends, most banks will automatically roll your CD’s balance into a new CD with the same term as the original. For example, if you had a one-year CD, the bank will put the money into a new one-year CD.

That means that if you don’t make changes, such as choosing a different term for your new CD, or withdrawing your money during the grace period, you’ll wind up with a new CD with the same term automatically. If you want to withdraw money after the grace period ends, you’ll have to pay the early withdrawal fee.

Pros & Cons of CDs

Many people like the idea of opening a CD because it lets them earn a bit more interest compared to a traditional savings account while still providing the safety of FDIC protection. However, locking your money into a CD also brings interest rate risk and liquidity risk.

Pros of CDs

CDs offer many advantages, including safety and higher rates.

  1. Higher Interest Rates Than Savings Accounts. CDs will generally offer higher interest rates than savings accounts, especially once you reach longer terms.
  2. FDIC Insurance. A CD receives the same FDIC protection that a checking account or savings account receives.
  3. Fixed Interest Rates. Most CDs have a fixed interest rate. You know exactly how much interest your CD will earn over its term and you can plan for that. Unlike other financial products with variable rates or the stock market, you can perfectly predict the return. Fixed rates are also a boon when market rates fall, letting you earn better than market rates for the remainder of your term.
  4. Variety of Terms. Many banks will give you multiple options for CD term lengths. You can usually find options ranging from a few months to five or more years, letting you customize your account.

Cons of CDs

CDs can be great for savers, but they’re not without risk. You need to plan around opening a CD and make sure you won’t have to make an early withdrawal.

  1. Loss of Liquidity. When you open a CD, you promise not to make withdrawals during the CD’s term. If you need access to your money before the CD matures, you’ll pay a penalty.
  2. Lower Returns Than Other Investments. If your goal is to maximize your returns, CDs are only slightly better than high-yield savings accounts, bonds, and other investments may be a better choice for those seeking a better rate of return.
  3. Fixed Interest Rates. While fixed rates are a pro of CDs, they’re also a con. If interest rates increase after you lock in your CD’s rate, you’ll be stuck earning a lower interest rate, missing out on potential returns.

Should You Open a Certificate of Deposit?

There are a few situations where opening a CD can be a good idea.

If you have a specific goal and timeline in mind, a CD can be a good way to keep your money safe and earn a better return than you would with a regular savings account.​​ For example, if you plan to buy a new car a year from now, a CD may be a good option.

You might also consider a CD if you predict that the interest rate environment will see falling rates in the future. Locking in a higher rate now can let you earn a better return on your money.

CDs are generally a bad idea if you need quick and easy access to the money in the account. They’re also not the best choice for long-term investing unless your risk tolerance is very low. More volatile investments, such as stocks or mutual funds, typically offer higher returns over the long term, even if they can see decreases in value in the short term.

Certificate of Deposit FAQs

CDs are a good fit in many circumstances, but it’s important to fully understand how they work before you open one.

What’s the Difference Between a CD & a Savings Account?

CDs and savings accounts are quite similar, serving as safe places to store your extra cash and to earn interest.

The primary difference between them is that savings accounts are more flexible, allowing for withdrawals whenever you need. CDs limit withdrawals to when they mature.

Where Can I Get a CD?

You can get a CD from most banks and credit unions. You may also be able to buy brokered CDs through your brokerage account.

Are CDs FDIC-Insured?

Yes, CDs that you open at a bank are fully insured by the FDIC for up to $250,000. The National Credit Union Administration offers similar coverage for CDs issued by credit unions.

How Are CDs Taxed?

CDs pay interest and you need to pay income tax on the interest that you earn. You can avoid or defer these taxes by opening a CD in a retirement account like an Individual Retirement Account (IRA).

What Is a CD Ladder?

A CD ladder involves opening multiple CDs with different terms so that you have CDs maturing on a regular schedule. 

For example, you could open four CDs and set their maturities so that one matures every three months. This lets you earn a higher rate on your savings while maintaining some level of liquidity.

What Is a Negotiable Certificate of Deposit (CD)?

Negotiable CDs are a special type of CD with a minimum face value of $100,000 and terms ranging from a few weeks to a year. They can’t be redeemed before their maturity date and offer interest payments either twice a year or on their maturity date. 

Typically, investors can sell negotiable CDs on the open market. The market for negotiable CDs is relatively liquid.

Final Word

A CD is a solid option if you’re looking for a safe place to store your excess cash. In return for the limitations on when you can access your savings, they offer higher interest rates than savings accounts. However, they aren’t ideal for long-term saving due to their lower returns when compared to options like stocks and bonds.

When opening a CD, make sure to shop around with your local banks and credit unions, as well as online banks. That’s the best way to find the best available rates.

TJ is a Boston-based writer who focuses on credit cards, credit, and bank accounts. When he's not writing about all things personal finance, he enjoys cooking, esports, soccer, hockey, and games of the video and board varieties.