How do CDs work? Learn about rates and terms
Key takeaways
- A CD account is a type of savings account that locks your money for a set period in exchange for a guaranteed interest rate.
- CDs work by requiring you to deposit money for a fixed term, during which you can’t withdraw without paying penalties.
- Banks offer CD terms from 3 months to 5 years, with rates that are often higher than regular savings accounts.
- Your money is FDIC-insured up to $250,000, making CDs one of the safest ways to earn guaranteed returns.
A certificate of deposit (CD) is basically a savings account with a twist — you agree to leave your money alone for a specific period, and in return, the bank guarantees you a fixed interest rate that’s usually better than what you’d get from a regular savings account.
Think of it as a deal you make with your bank: You promise not to touch your money for six months, two years or whatever term you choose, and they promise to pay you a specific interest rate that won’t change during that time. It’s one of the safest ways to grow your money if you don’t need immediate access to it.
Here’s everything you need to know about how CDs work and whether they’re right for your situation.
What is a CD account and how does it work?
A CD is a time deposit account where you agree to keep your money deposited for a specific period called a “term.” During this time, your money earns a fixed interest rate that won’t change, regardless of what happens to interest rates in the general market.
“CDs offer something that’s become rare in today’s financial world — complete predictability. You know exactly how much you’ll earn and when you’ll get it back. For people who want to eliminate guesswork from part of their savings strategy, CDs deliver that certainty.”— Hanna Horvath, CFP & Bankrate Banking Editor
Here’s how a CD works in simple terms: You give the bank your money, choose how long you want to leave it there (the term), and the bank tells you exactly how much interest you’ll earn. At the end of the term, you get back your original money plus all the interest you earned.
The catch is that if you need your money before the term ends, you’ll pay an early withdrawal penalty. This penalty is how banks make sure you stick to your end of the deal.
Learn more: Are CDs worth it right now? Here’s what the experts say.
CD basics: Important factors to consider
Here are several factors to consider when shopping for a CD.
CD terms
The relationship between CD rates and terms is pretty straightforward — usually, the longer you’re willing to tie up your money, the higher interest rate you’ll earn. Banks reward you for making a longer commitment.
CD terms typically range from three months to five years, though some banks offer longer terms. Common options include 6-month, 1-year, 2-year and 5-year CDs. Some banks and credit unions issue CDs with unconventional terms, such as seven, 13 or 17 months. Banks often assign such irregular terms to no-penalty CDs or to promotional CDs, which are typically offered for a limited period of time and offer highly competitive yields.
Generally, longer terms pay higher interest rates because you’re committing your money for more time.
If you put $10,000 in a 1-year CD earning 4.40% APY, you’ll earn about $440 in interest. Put that same $10,000 in a 3-year CD earning 4.15% APY, and you’ll earn almost $1,300 total — about $850 more despite the lower rate, thanks to the longer time period.
The key is understanding what economists expect to happen with interest rates. If rates are likely to rise, you might want shorter terms so you can reinvest at higher rates later. If rates are expected to fall, longer terms can lock in today’s good rates.
Compare your options: Today’s best CD rates
Types of CDs
Not all CDs work the same way. Banks offer several different types to meet different needs and preferences.
Traditional CD
A traditional CD is the standard version — you make one deposit, choose a term and earn a fixed rate until maturity. These are the most common and usually offer the best rates if you can commit to leaving your money alone.
No-penalty (liquid) CD
These CDs allow let you withdraw your money early without paying fees, but they typically offer lower interest rates in exchange for this flexibility. No-penalty CDs are good if you think you might need access to your money but want better rates than a savings account.
Bump-up CD
A bump-up CD allow you to request a higher rate if the bank raises its CD rates after you’ve already opened your account. You usually get one or two “bumps” during the term.
Step-up CD
A step-up CD automatically increases your interest rate at predetermined intervals. For example, you might start at 3 percent for the first year, then jump to 3.5 percent for the second year.
IRA CD
IRA CDs are held inside retirement accounts and offer the same safety as regular CDs but with tax advantages. These work well for conservative investors who want guaranteed returns in their retirement portfolios.
CD safety and insurance protection
CDs are among the safest investments you can make. When you open a CD at an FDIC-insured bank or NCUA-insured credit union, your money is protected by federal insurance up to $250,000 per depositor, per institution.
This means even if the bank fails completely, you’ll get your money back up to the insurance limit. It’s the same protection that covers regular savings accounts and checking accounts. The guarantee extends to both your original deposit and any interest you’ve earned. Unlike investments in stocks or bonds, there’s no market risk with CDs — you can’t lose money as long as you stay within FDIC insurance limits.
For deposits over $250,000, you can spread your money across multiple banks or use different ownership categories (like individual vs. joint accounts) to get full insurance coverage on larger amounts.
Related reading: How FDIC insurance protects your CD investments
CD early withdrawal penalties
While CDs offer guaranteed returns, they come with strings attached. If you withdraw money before the term ends, you’ll face early withdrawal penalties that can eat into your earnings or even your principal.
Penalty amounts vary by bank and term length. A typical penalty might be 60 days of interest for a 1-year CD or 180 days of interest for longer terms. Some banks charge even more — up to a full year’s worth of interest for early withdrawals.
You can lose part of your original deposit if the penalty exceeds the interest you’ve earned. For example, if you withdraw after earning only 60 days of interest but owe a 90-day penalty, the bank will take the remaining 30 days from your principal.
The exact penalty depends on your bank’s policy, how much money is in the CD, and how long the term is. Before opening any CD, make sure you understand the specific penalty structure and are confident you won’t need the money during the term.
It’s possible to lose part of your initial deposit in a CD if your early withdrawal penalty exceeds the interest earned.
For instance, if you have to pay a penalty of 90 days’ worth of interest and you’ve only earned 60 days’ worth to date, the remaining 30 days’ worth of interest would be taken out of your principal.
How to choose the right CD
Picking the right CD depends on your financial goals, timeline, and comfort with locking up your money.
- Consider your timeline first. If you’re saving for a house down payment in 18 months, an 18-month CD makes sense. If you just want to earn better returns on money you won’t need for several years, a longer term might work better.
- Compare rates across different terms. Don’t assume longer terms always pay more. In today’s market, you might find that a 1-year CD pays as much as a 3-year CD, making the shorter term a better choice.
- Factor in your other savings. Don’t put all your money in CDs. Keep some funds in liquid savings accounts for emergencies and unexpected opportunities.
- Consider building a CD ladder, where you open multiple CDs with different maturity dates. This gives you regular access to funds while keeping some money earning higher long-term rates.
How to open a CD
Opening a CD is similar to opening any bank account. You’ll need basic information like your Social Security number, driver’s license, and contact details. Many banks let you open CDs online, making the process quick and convenient.
Minimum deposits vary by bank. Some banks like Ally and Capital One require no minimum deposit, while others like Marcus by Goldman Sachs require $500. Jumbo CDs typically require $100,000 or more but may offer slightly higher rates.
Fund your CD using money from another account at the same bank, a transfer from another institution or a check. Once your CD is funded, you’ll typically receive confirmation of your term, rate, and maturity date.
Track your maturity date to avoid automatic renewals at potentially lower rates. Most banks send notices before your CD matures, but it’s smart to set your own calendar reminders.
What happens when my CD matures?
When your CD reaches its maturity date, you enter a grace period — usually about 10 days — during which you can decide what to do with your money without penalty.
Your options include withdrawing the money, transferring it to another account or rolling it into a new CD. If you do nothing, most banks will automatically renew your CD for the same term at whatever rate they’re currently offering.
Don’t let automatic renewal happen without thinking about it. The new rate might be much lower than what you originally earned, especially if interest rates have fallen since you opened the CD.
How much should you invest in a CD?
The amount you put in CDs depends on your overall financial situation and goals. CDs work best for money you’re certain you won’t need during the term — think of them as part of your medium-term savings strategy.
Keep your emergency fund separate in a high-yield savings account where you can access it immediately. Most financial experts recommend 3-6 months of expenses in easily accessible savings before considering CDs. Here are the best places to store your emergency savings.
Don’t put all your money in CDs, even though they’re safe. While CD rates are currently competitive, they might not keep up with inflation over very long periods. Consider balancing CDs with other investments for long-term wealth building.
Start small if you’re new to CDs. Many banks have low or no minimum deposits, so you can try a shorter-term CD to see how it works before committing larger amounts or longer terms.
Bottom line
Ready to explore CD options? Compare today’s best CD rates to find competitive terms that match your timeline, or check out high-yield savings accounts for money you need to keep accessible.
If you’re building a complete savings strategy, consider money market accounts that offer some of the benefits of both savings accounts and CDs.
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