How do CDs work?

Certificate of deposit (CD) definition

A certificate of deposit (CD) is a low-risk savings account that offers a higher interest rate than a traditional savings account. However, they’re less flexible than a traditional savings account, since you can’t withdraw money without a penalty—which is typically why they offer a higher interest rate.

After depositing your funds, the money in a CD account is held, earning interest, until the term matures. While it’s possible to access your money, a withdrawal will usually result in an early withdrawal penalty.

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How CDs work

Unlike a traditional savings account, a CD account is a fixed-term investment (unless it’s a specialty CD product). Most CD accounts earn the same rate throughout their term; the benefit of a fixed rate is that you can easily calculate the return on your investment for specific durations.

Once you’ve invested the funds, the financial institutionb is locked into the rate you’ve agreed to. This can be an advantage if you lock in a high rate and bank rates subsequently fall. But the opposite is also true—you can get locked in at a lower rate and then see rates start climbing.

Opening a CD account is similar to opening any deposit account, and it can be done in person, over the phone or online. However, many financial institutions will require a minimum deposit. This amount can range dramatically, from a few hundred dollars to several thousand dollars. Some digital banks offer CDs with no minimum deposit required, while a “jumbo” CD usually comes with a $50,000 or $100,000 minimum deposit.

Each bank or credit union determines their own rates, minimum deposit requirements and early withdrawal penalties (and whether the CD account will be automatically reinvested at time of maturity unless otherwise directed). Once you open a CD account, you’ll typically receive a monthly or quarterly statement, where you can see your monthly or quarterly interest payments accumulate.

However, if you need to access that money, early withdrawal fees could eat away at any interest you’ve accumulated—or even your original deposit amount. So a CD typically isn’t the best option for an emergency account.

CD interest rates

For years, certificates of deposit have paid microscopic rates—but that all changed in 2022-2023. That’s because CD rates are influenced by the Federal Reserve’s federal funds rate, the target rate at which commercial banks borrow and lend their reserves. In 2008, the Fed reduced its rate to the lowest possible level as a stimulus to lift the country out of a recession. Rates remained low for years, which meant CD rates were also low.

But over the past year, amid rapid inflation, the Fed has aggressively raised interest rates, which is now holding steady at a range of 5.25% to 5.50%. As a result, many CDs are now offering rates well above 5%.

Financial institutions offer CD investments with varying terms and interest rates, so you can find the right fit for your personal goals. Small, local financial institutions may offer a better rate than larger institutions, and online banks—which cut out overhead costs—can often offer highly competitive rates with low or no minimum deposit requirements. It’s also worth keeping an eye out for promotional CD rates, which could come with higher-than-average yields.

CD terms

CD investments offer a wide range of terms, from as short as a few months to as long as five years. Typically, the longer the term, the better the rate. But choosing the term of a CD account shouldn’t be based on the rate alone.

Also consider the Fed’s plans. If rates are expected to keep increasing, then you may want to consider a shorter-term CD so you don’t end up locked into a lower rate. But if rates are expected to drop, then you may want to consider a longer-term CD to benefit from a higher rate.

It’s also worth considering why you’re setting aside that money. If you’re saving for a specific goal, like a wedding or down payment on a home, you’ll have a specific end-date in mind. But if you’re saving for retirement, you may opt for a longer-term CD to maximize on compounding interest.

A popular strategy for maximizing higher rates is using a CD ladder, where you divide your money across multiple CD accounts with different terms. This allows you to benefit from high rates in longer-term CDs, while having cash available to invest in new opportunities as shorter-term CDs mature.

CD account minimum

In order to open a CD account, you’re typically required to make a minimum deposit—although some digital banks offer CD accounts with no minimum deposit requirements. Each bank and credit union has their own requirements; some will have a standard deposit requirement across all CD terms, while others may have different deposit requirements for different terms. For example, some banks may offer a higher rate if you meet a higher deposit threshold.

But don’t assume that a higher minimum deposit will naturally result in a higher return. In the current competitive environment, many top rates in each CD term can be achieved with a modest investment of $500 or $1,000. And a jumbo deposit of $50,000 or $100,000 is only occasionally required to benefit from a higher rate.

CD maturity date

The maturity date of a CD refers to the end of the fixed term you agreed to, which could be a few months or up to five years. When your CD account is reaching maturity, you typically have three options; withdraw your money, transfer it into another account at the same bank or credit union, or roll over the balance into a new CD.

Your financial institution will notify you when you’re nearing the maturity date, with instructions on what to do next. If you don’t do anything, or if you miss the deadline for instructing the bank on what to do, your money will likely be automatically renewed in the CD, usually for the same term—but at the latest interest rate. And if the rate is subpar, you’ll be locked in or incur early withdrawal penalties if you want to remove the funds.

How different types of CDs work

While traditional CDs offer a fixed rate for a fixed term, there are other types of CDs worth considering. Some options may offer a lower rate than a traditional CD, but they come with additional perks, such as the ability to withdraw early without penalty. Depending on your goals, you may want to consider specialized CD products, such as:

Liquid CDs: With a liquid CD, sometimes called a no-penalty CD, you can make withdrawals without a financial penalty. But that often means you’ll have to accept a lower rate than a traditional CD.

Variable CDs: With a variable CD, the interest rate on your account will rise and fall according to a specific benchmark, such as the prime rate, the Consumer Price Index or the performance of the S&P 500.

Add-on CDs: With an add-on CD, you can increase your principal by making additional deposits. Depending on the CD product, add-on deposits could be unlimited for the duration of the term or limited to a certain number.

Bump-up CDs: A bump-up CD, sometimes called a raise-your-rate CD, gives you a limited number of “boosts” to your interest—usually just once or twice during the term—which allows you to take advantage of rising rates. However, to get that flexibility, you may have to accept a lower interest rate when you initially open the account.

IRA CDs: An individual retirement account (IRA) CD can be useful if you’re close to retirement and want dependable returns. IRA CDs don’t have the high returns of stocks, but they don’t come with the same risks, either. They’re usually fixed-rate accounts, but there are other options too, like a step-up IRA CD (with rates that increase at set intervals) or bump-up IRA CD (where you can request a “bump” if interest rates increase).

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Where to buy a CD

You can buy a certificate of deposit at almost any financial institution, from brick-and-mortar national banks, to digital banks with no physical branches, to local credit unions (however, credit unions may refer to them as share certificates rather than CDs). You also have the option of opening a CD through a brokerage rather than a bank.

When considering where to open a CD account, look beyond the institution where you do most of your daily banking. CD rates and terms vary widely, so it’s worth shopping around. For example, digital banks may offer a higher APY on CD products, though they typically come with less flexibility. If you need flexibility, you may want to consider a specialized CD or brokered CD.

Are bank CDs a safe investment?

CDs are considered a safe investment since the rate you signed up for is the rate you get—there’s no risk of losing your money. The main “risk” of a CD is opportunity risk, which means you’re locked in if rates keep rising. Or, it may not keep up with inflation.

Like other savings accounts, CDs are federally protected up to $250,000 if they’re held with a bank insured by FDIC or a credit union insured by NCUA. If you’re investing more than $250,000, spreading those funds across multiple institutions can ensure your funds are as safe as possible.

But in today’s current fiscal environment, CDs are worth considering as a safe, reliable option to earn high interest while keeping your principal secure.