Think of certificates of deposit as interest-bearing savings accounts — with a few key differences. A CD is sold by financial institutions like banks, brokerage houses and credit unions. CDs are considered a low-risk investment because they are generally FDIC-insured up to a high limit and because, when held to the end of the term, a CD will return the full amount of the original investment plus interest.
Because of the way they are structured, CDs can be ideal for someone who has extra cash that he won’t need for an extended period and wants to use to earn more interest than he would from a money market or savings account, without having to risk the principal investment.
CDs differ from traditional savings accounts because a CD requires that you deposit a certain amount — typically anywhere from about $50 to $100,000 — for a certain amount of time — anywhere from 30 days to five or more years. You’ll earn interest on your money, and the interest rate is usually fixed for the term of your CD. If you withdraw your money early, you will likely be charged a penalty.
Depending on which financial institution you bank with, your bank or credit union’s CD products might also be referred to as:
- Term certificates
- Term CDs
- Savings certificates
- Time deposits
A number of different types of CDs are available, as well as various strategies to maximize your earnings. So before you tie up your extra cash in a CD, learn all the options to find out which CD or CDs might be right for you.
Different Types of CDs at a Glance
Almost as many types of CDs exist as there are types of savers. Use this guide to help narrow your search and find the type of CD that will best suit your financial goals. Here are the types of CDs:
|CD Type||Key Features||Factors to Consider|
Term lengths, rates and minimum deposit requirements vary by institution and also depend on factors such as the federal funds rate.
Pros and Cons of CDs
CDs come with many advantages, but they also have drawbacks. And because you probably won’t be able to withdraw your money until the end of the CD’s term without paying a hefty penalty, it’s important to know all the facts. Here are some of the pros and cons to consider.
Advantages of CDs: Low Risk and High Interest Rates
CDs are insured by the FDIC up to $250,000, so you can invest knowing your money — up to that amount — is secure. Other advantages of CDs include:
- Low risk: You can easily find CDs that are FDIC-insured up to $250,000. If you follow the terms of your CD, you can expect to get back the full amount of the original investment, plus interest if it’s an interest-bearing CD.
- Higher interest rates: CDs typically offer better interest rates than most money market, checking and traditional savings accounts.
- Fixed rates and terms: With a fixed-rate CD, you’ll know exactly how much your money will earn over a definite period of time.
- Straightforward investment strategy: CDs can be easy to understand and easy to use.
- Availability: CDs are offered at a variety of financial institutions.
Keep Reading: Things to Know About High-Yield CDs
Disadvantages of CDs: Low Liquidity and Lower Earning Potential
Despite the ease and security of investing in a CD, there are some negative factors to consider before you decide what to do with a lump sum of your money:
- Low liquidity: Your money will be tied up, and you will likely not be able to withdraw your money early without paying a hefty penalty.
- Lower interest rates: CDs offer lower interest rates than other, riskier investments.
- Lower earning potential: Long-term CDs run the risk of earning less than the rate of inflation if inflation rises.
CD Interest Rates Made Easy
When you open a CD, you are entering into an agreement with the bank or financial institution issuing it. Typically, you promise not to withdraw your money for a certain amount of time; the bank agrees to pay you a specific, typically fixed, interest rate for that period. Here’s an example of how CD interest is calculated: If you buy a one-year, $10,000 CD with an interest rate of 2 percent annual percentage yield compounded annually, then at the end of one year, your CD would be worth $10,200.
Finding the best CD rates is a matter of searching the web and asking financial institutions about their CDs. Keep a couple things in mind: The longer the term and the more you invest, the higher the APY is likely to be. Also, your best bet for getting a higher APY is to search for online bank CD rates and credit union CD rates, as opposed to rates at national brick-and-mortar banks. Online banks and credit unions have lower overhead costs than national and brick-and-mortar banks; those savings are passed down to customers in the form of higher interest rates.
Because even the best CD interest rates won’t make you rich quickly, you might want to take advantage of ways to maximize your CD earnings. Strategies include CD laddering, promotional rates, variable-rate CDs, liquid CDs and bump-up CDs.
Answers to CD Interest Rate FAQs
Learn the answers to the most frequently asked questions about CD interest rates so you can decide whether this type of investment is right for you.
What Is a Bump-Up CD?
A bump-up CD or bump-rate CD is one in which you have the option to “bump up” to a newer, higher interest rate if rates rise during the term of your CD. A bump-up CD is usually limited to one increase, and your initial rate will likely be lower than that of a traditional CD of the same amount and duration.
Does My Principal Affect My CD Rate?
Yes. Generally, the higher your balance, the higher your interest rate.
How Do Yield Curves Affect CD Rates?
A yield curve is a graph that shows the yield of bonds of similar quality against their maturities. Usually, short-term interest rates are lower than longer-term rates. But that is not always the case. Sometimes, the yield curve steepens — the gap between rates on short-term and long-term bonds increases. The gap could mean that interest rates will rise, so you might want to limit your CD investments to short-term CDs, such as six-month CDs.
If the yield curve is downward-sloping, meaning rates could be expected to fall, you might choose to grab the presumed higher rate on longer CDs. But keep in mind that a yield curve is only a prediction, and the trend it indicates is not guaranteed.
Keep Reading: How Yield Curves Affect CD Rates
What’s the Difference Between the CD Interest Rate (APR) and the CD APY?
The APR is the interest rate that the bank is offering on the CD. The APY tells you how much you will actually earn as your money compounds.
For example, if you buy a 12-month, $1,000 CD with an interest rate of 1.2% APR and 1.21% APY, the CD would be worth $1,012.10 at the end of one year.
CD Fees and Costs
CDs typically come with significant penalties for early withdrawal. Common penalty amounts are six months’ worth of interest on a five-year CD, with some banks charging 12 months’ worth of interest, for example. In some instances, the penalties can even dig into your principal, meaning you would lose some of the money you originally deposited for withdrawing early.
Other potential costs associated with CDs are fees. For example, brokered CDs, which are offered through a stock broker or other investment professional, sometimes require fees like a flat fee or a percentage of the amount you are investing. So before you lock your money in, make sure the interest rate is worth it.
Finding a CD That’s Right for You
When shopping for CDs, you’ll want to factor in more than just the interest rate. Before you open a CD, make sure it’s the right one for you by first answering a few important questions:
- When will you need this money? Most CDs come with heavy penalties for early withdrawal, so don’t let a higher rate seduce you into tying up money you might need soon. If there’s a chance you’ll need the money, choose a shorter term or a CD without a penalty for early withdrawal.
- Do you have an emergency fund? Make sure you aren’t using emergency funds for the CD. If you find yourself in a real emergency without dedicated emergency funds, you might end up resorting to using a credit card for your immediate expenses — and losing money by carrying a balance or having to take a cash advance.
- Does the CD automatically roll over? If the answer is yes, make sure you take actions to remind yourself of the date your CD matures. If you forget, the bank will roll the CD over automatically, and you won’t be able to access your money for another term.
- Do you think interest rates will rise or fall? The vast majority of CDs have a fixed interest rate for the life of the term. So, if you believe rates will rise in the future, perhaps you should accept a shorter term — and likely, a slightly lower interest rate — so you can renew to a higher rate later.
- Can you accept loss on inflation? If you are investing in a long-term CD, remember that there’s always a chance that inflation outpaces your interest. At that point, you’re actually losing buying power. Decide whether you are comfortable with that risk before proceeding with a long-term CD.
How to Open a CD Account
A few requirements must be fulfilled to open a CD account. For example, for most CDs, you’ll need to be at least 18 years old or have a co-signer, and you’ll need to provide some form of ID. Here’s a breakdown of the typical steps involved in opening a CD account:
- Research banks, credit unions and other financial institutions to find the best interest rate.
- Once you’ve selected a CD, make sure you have access to the full amount of money you want to invest.
- Provide at least one type of proof of ID, such as a driver license.
- Provide proof of a verified checking account.
- Fill out and submit bank forms with your personal information.
- Transfer your investment amount — by check, cash deposit, or electronic or wire transfer — into the the CD account.
Once you’ve completed these steps, the bank will issue you CD documents with the amount, interest rate, APY, maturity date and other vital information. To avoid automatic renewal of the CD after it matures, set a reminder for the CD’s maturity date.
Related: Find Higher CD Interest Rates Now
If you’re unsure about how long you want to tie up your money in CDs, or if you believe interest rates will climb in the near future, a CD laddering strategy might be right for you. CD laddering is a way to keep your investment somewhat liquid and can result in higher growth rates.
To create a CD ladder, simply divide up your total investment into smaller sums, buying CDs of varying terms. For example, instead of buying one CD worth $30,000, you might buy three $10,000 CDs — one each at six-, 12- and 18-month terms. By doing this, one-third of your money becomes liquid every six months.
When one CD matures, you can either use the cash for something else or reinvest it in another 18-month CD, keeping the ladder strategy going. In addition to added liquidity, this strategy also allows you to maximize interest rates because, upon the second round, you are always investing in longer-term CDs.
You can do this in any combination with any term lengths. If liquidity is of utmost importance, use shorter maturities, such as three-month terms. For less liquidity but higher rates, go for intervals of one year or higher.
Laddering-Related CD Strategies
You can use a few laddering-related CD strategies that help combine greater liquidity with greater interest rates. One of these strategies is a CD barbell: You put half your investment into short-term CDs and half into long-term CDs. With this strategy, you’ll have some flexibility with the short-term investments and get better interest yield with the longer-term accounts. Overall, you’ll get a medium yield average.
Another strategy is a CD bullet, in which you buy CDs that have the same maturity date at different times. So the first year, you buy a 10-year CD, the second year you buy a nine-year CD, and so on. With the CD bullet strategy, you minimize the risk of missing out on higher interest rates by staggering your purchase dates. A CD bullet strategy could be useful for maximizing savings for a specific goal with a predetermined payment date, such as college tuition or retirement.
Alternatives to CDs
CDs aren’t the only savings instrument available; many alternatives are offered that might better suit your particular needs and goals. Here are a few common alternatives to CDs:
|Alternative Account Type||Key Differences From a CD||When to Use It|
|High-yield savings account|
|Money market account|
|U.S. Series I savings bonds|
|U.S. Series EE savings bonds|
Answers to General CD FAQs
Take a look at some answers to more general FAQs about CDs to help you decide how to proceed with this type of investment.
Should CD Beneficiaries Renew?
If you inherit a CD, the first thing to do is clarify your options with the bank where the CD is held. If you have the option to renew and you want to, check to make sure you’re getting the best possible rate. You might also consider other types of investments or close out the CD upon maturity.
What Is a CD Auto-Renewal?
When your CD is coming up for maturity, the bank will notify you. If you do not withdraw your money or inform the bank what to do with the money, the bank might reinvest your money into a new CD with similar terms. Auto-renewal deprives you of the option to shop for the highest current CD rates, the term length you’d prefer or the option to close the account.
How Do I Invest in Long-Term CDs Without Losing Liquidity?
One way to invest in long-term CDs without losing liquidity is to create a CD ladder. By using a CD ladder strategy, you divide the amount you invest in many CDs with different maturity dates so that you are always close to the maturity date of at least some of your money.