What Is a Certificate of Deposit (CD)?
A certificate of deposit is a time-deposit savings account that offers fixed returns (usually higher than those of savings accounts) in exchange for your keeping funds with the bank for a certain length of time (known as a term length, the end of which is called a maturity date). The APY often differs based on the term length, which can range from one month to 10 years. Many CDs require minimum deposits, but some banks, like Ally and Barclays, don’t.
Like other deposit accounts, CDs are insured either by the Federal Deposit Insurance Corporation (FDIC) or by the National Credit Union Administration (NCUA), which means that your deposit of up to $25,000 is protected if your bank or credit union were to collapse.
If you withdraw funds, you may have to pay a penalty. This will differ depending on how long the money has been in the CD, but this fine could potentially eat into the principal. For this reason, we do not recommend treating CDs like checking accounts, which allow free, unlimited transfers.
For more information, check out our review of the best certificates of deposit currently available from online and traditional banks, or read on to learn more about how CDs work.
Certificate of Deposit FAQ
What are the different types of CDs?
There are a few different variants of CDs that banks and credit unions offer. The main types are:
- High-yield CD: A traditional CD, but with “high-yield” in the name to call out high rates of return.
- No-penalty CD: Also known as liquid CDs and breakable CDs. You do not have to pay an early withdrawal penalty if you make a withdrawal, but the trade-off is that the fixed APY is lower than that of a regular CD. Not commonly offered.
- Bump-rate CD: Also known as a step-up CD. Offers you the option of increasing your APY to the current rate one time during the term length. Typically, your APY is fixed through the CD length.
- Variable-rate CD: Interest rate can vary throughout the term length, depending on changes to the bank’s APY. Not recommended if the Federal Reserve has been cutting interest rates.
- Jumbo CD: Intended for minimum deposits of $100,000 or more, which can earn a higher interest rate.
What’s the difference between a CD, a savings account, and a money market account?
A CD is a time-deposit account that requires funds to stay in the account for a fixed period of time in order to realize the full rate of return. Because it’s the most restricted type of deposit account, banks give CDs the highest APY.
Conversely, savings and money market accounts are easier to access, but they offer lower APYs. With these accounts, you can make up to six free withdrawals or transactions per month.
|CD||Savings Account||Money Market Account|
|FDIC- or NCUA-insured||✔||✔||✔|
|Access to cash||Withdrawals before the maturity date subject to penalty||6 monthly transactions max, including withdrawals and transfers||6 monthly transactions max, including withdrawals and transfers|
|Interest rates (relative to each other)||High||Low||Medium|
How does the early withdrawal penalty work?
Banks tend to handle withdrawal penalties differently, but essentially, if you withdraw your funds from a CD before the maturity date, you forfeit interest on the account.
“If you cash out prior to maturity, the penalty could involve some initial loss of your investment, so be very careful about what maturity you invest in,” says Greg McBride, CFA, who is Senior Vice President, Chief Financial Analyst of Bankrate. “In other words, if you need the money in a year, don’t put it into a two-year CD. You’re not going to come out ahead.”
Take, for example, the CD penalty policy from Ally Bank (below). The penalties are tiered based on the CD term length. If you withdraw a 24-month CD at the 12-month mark, then you forfeit about two months (or one-sixth) of the interest accumulated.
|24 months or less||60 days of interest|
|24-36 months||90 days of interest|
|37-48 months||120 days of interest|
|49 months or more||150 days of interest|
Exceptions to the early withdrawal penalty can be made if the depositor dies or is judged legally unable to make financial decisions.
Who should use CDs?
People who might benefit from a CD include:
- People saving for fixed goals, such as a wedding or mortgage
- Retirees who want to draw out their retirement savings
- Savers who want the peace of mind of FDIC insurance
CDs should not be used for:
- Emergency savings
- Money you may have to withdraw before the maturity date
- The bulk of your retirement savings prior to retirement
Are CDs risk-free?
CDs are relatively safe investments (since they are insured by the FDIC or NCUA). They’re often chosen as high-yield alternatives to savings accounts and stable alternatives to the stock market. However, they’re not risk-free.
“There are inherent risks in fixed income securities,” says Brent Weiss, CFP, Chief Evangelist of Facet Wealth, citing interest rate risk and reinvestment risk. Essentially, because CDs often rely on fixed interest, there is potential opportunity cost if overall interest rates climb while your money is locked in. On the other hand, if overall interest rates drop dramatically, you’ll be paid much less if you decide to roll over your CD into another maturity.
There’s also the matter of interest rates keeping up with inflation, which is at 1.8% as of November 2019. If your CD APY is not higher than the inflation rate, the funds lose value in the long term.
Can I add money to a CD?
No. In almost all cases, you would need to purchase another CD in order to invest more funds. Think of the money in each CD as being locked up.
Why do CD interest rates change so much?
The U.S. Federal Reserve increases and decreases federal interest rates to affect particular macroeconomic changes in the economy. This is why, in 2019, you may have noticed that interest rates on your deposit accounts have been going down steadily over the past several months — even from online banks that have prided themselves on high yields. The Fed has decreased interest rates three consecutive times this year to sustain economic growth and hedge against a potential recession.
What is CD laddering and how does it work?
CD laddering is a strategy that people use to take advantage of multiple interest rates and multiple opportunities to withdraw cash, if needed. This requires buying CDs of varying term lengths that will expire at different times.
“The laddered structure smooths out peaks and valleys in interest rates and provides a more predictable stream of interest income,” McBride says.
Laddering CDs over a short period of time is particularly valuable for known goals, as the strategy allows for high returns while allowing you some liquidity. Weiss cites saving for college as an example. “If you have some cash saved for the four years, you could ladder CDs over those four years so that they mature prior to when the payments are due. It’s a low risk strategy with a set time table to help you balance the day-to-day of your financial life.”
“With today’s interest rate environment, [CD laddering] is a good solution for consumers that are either looking for slightly higher interest rates or that have larger, upcoming expenses in the next 12 to 24 months,” he continues. However, he cautions, “I would not go too far beyond this time period given interest rate uncertainty.”