What Is a Certificate of Deposit?
A certificate of deposit (CD) is a type of savings account offered by banks and credit unions that pays a fixed interest rate in exchange for keeping your money deposited for a set period of time. Unlike a regular savings account where you can withdraw funds at any time, a CD requires you to leave your deposit untouched until the maturity date — the point when the agreed-upon term ends.
In return for this commitment, CDs typically offer higher interest rates than standard savings accounts. They are considered one of the safest investment vehicles available because deposits at FDIC-insured banks are protected up to $250,000 per depositor, per institution. This makes understanding certificate of deposit basics essential for anyone looking to earn a reliable return with minimal risk.
"A CD is one of the simplest ways to earn a guaranteed return on your money without taking on market risk."
How Do CDs Work?
The mechanics of a CD are straightforward. When you open a CD, you agree to three key terms:
- Deposit Amount: The principal you invest, which can range from as little as $500 to $100,000 or more
- Term Length: The duration your money will be locked up, typically ranging from 3 months to 5 years
- Interest Rate (APY): The annual percentage yield you will earn, which is fixed for the entire term
Once the CD matures, you receive your original deposit plus all accrued interest. Most banks offer a grace period of 7 to 14 days after maturity during which you can withdraw your funds, renew the CD, or change the term without penalty. If you take no action, many banks will automatically renew the CD at the current rate for the same term.
How CD Interest Is Calculated
CD interest is typically compounded daily or monthly, which means you earn interest on your interest over time. The annual percentage yield (APY) reflects the total amount of interest you earn in a year, including the effects of compounding. A CD with a 5.00% APY compounded daily will earn slightly more than one compounded monthly at the same nominal rate.
Types of CDs
Traditional CDs
The most common type, traditional CDs offer a fixed interest rate for a set term. You deposit a lump sum, and the rate remains locked until maturity. These are ideal when you want predictable, guaranteed returns and can commit your funds for the full term.
Jumbo CDs
Jumbo CDs require a larger minimum deposit, typically $100,000 or more. In exchange for the higher commitment, they often offer slightly better interest rates than standard CDs. These are best suited for investors with significant cash reserves who want a safe, higher-yielding option.
No-Penalty CDs
Also called liquid CDs, no-penalty CDs allow you to withdraw your full balance before the maturity date without paying an early withdrawal penalty. The trade-off is that they usually offer lower interest rates than traditional CDs. They provide a middle ground between the flexibility of a savings account and the higher rates of a standard CD.
Bump-Up CDs
A bump-up CD allows you to request a rate increase if the bank raises its CD rates during your term. Most bump-up CDs allow one rate increase over the life of the CD. This type is attractive in a rising interest rate environment, though initial rates are often lower than traditional CDs.
Step-Up CDs
Step-up CDs automatically increase your interest rate at predetermined intervals during the term. For example, a 3-year step-up CD might start at 3.5%, move to 4.0% after year one, and reach 4.5% in the final year. The blended rate may be lower than what a traditional CD of the same length offers.
Brokered CDs
Unlike bank CDs purchased directly, brokered CDs are sold through brokerage firms. They often come from multiple banks, giving you access to a wider range of rates and terms. Brokered CDs can be sold on the secondary market before maturity, providing more liquidity, but their market value can fluctuate based on interest rate changes.
CD Terms and Rates
CD terms typically range from short-term to long-term, and the interest rate you earn often correlates with the length of the term:
| CD Term | Typical APY Range | Best For |
|---|---|---|
| 3 Months | 3.50% - 4.50% | Short-term parking of cash |
| 6 Months | 4.00% - 5.00% | Near-term savings goals |
| 1 Year | 4.25% - 5.25% | Balancing rate and flexibility |
| 2 Years | 3.75% - 4.75% | Medium-term commitments |
| 5 Years | 3.50% - 4.50% | Locking in long-term rates |
Note that in some interest rate environments, shorter-term CDs may actually offer higher rates than longer-term ones. This is called an inverted yield curve and occurs when the market expects interest rates to decline in the future.
The CD Ladder Strategy
A CD ladder is one of the most popular strategies for CD investors. Instead of putting all your money into a single CD, you divide it across multiple CDs with staggered maturity dates. This approach combines the higher rates of longer-term CDs with regular access to a portion of your funds.
How to Build a CD Ladder
Here is an example of a basic 5-year CD ladder with $10,000:
- $2,000 in a 1-year CD — Matures in 12 months
- $2,000 in a 2-year CD — Matures in 24 months
- $2,000 in a 3-year CD — Matures in 36 months
- $2,000 in a 4-year CD — Matures in 48 months
- $2,000 in a 5-year CD — Matures in 60 months
When each CD matures, you reinvest it into a new 5-year CD. After the first year, one CD matures annually, giving you regular liquidity while all your money eventually earns 5-year rates.
Benefits of a CD Ladder
- Regular liquidity: Access a portion of your money every year without penalties
- Higher average rates: Blend short-term and long-term rates for a better overall yield
- Interest rate protection: If rates rise, you can reinvest maturing CDs at higher rates; if rates fall, your longer-term CDs are still locked at higher rates
- Reduced risk: Avoid committing all your funds to one rate or one maturity date
CDs vs Savings Accounts vs Bonds
Understanding how CDs compare to other safe investment options helps you decide where to put your money:
| Feature | CDs | Savings Accounts | Treasury Bonds |
|---|---|---|---|
| Interest Rate | Fixed, typically higher | Variable, typically lower | Fixed, varies by term |
| Liquidity | Low (penalties apply) | High (withdraw anytime) | Moderate (sell on market) |
| FDIC Insured | Yes (up to $250K) | Yes (up to $250K) | Backed by U.S. government |
| Minimum Deposit | $0 - $1,000+ | $0 - $25 | $100 (TreasuryDirect) |
| Best For | Known future expenses | Emergency funds | Long-term safe income |
Early Withdrawal Penalties
If you need to access your CD funds before the maturity date, most banks charge an early withdrawal penalty (EWP). The penalty varies by institution and term length but typically ranges from a few months to a full year of interest:
- CDs under 12 months: Penalty of 3 months of interest
- CDs of 12-36 months: Penalty of 6 months of interest
- CDs of 36-60 months: Penalty of 9-12 months of interest
- CDs over 60 months: Penalty of 12-18 months of interest
In some cases, the penalty can eat into your principal if you withdraw early enough in the term. Always read the terms and conditions before opening a CD, and keep an adequate emergency fund in a liquid savings account to avoid needing to break a CD early.
FDIC Insurance and CD Safety
CDs at FDIC-insured banks are protected up to $250,000 per depositor, per insured bank, per ownership category. This means if your bank fails, the federal government guarantees you will get your money back up to the insured limit. Credit union CDs (often called share certificates) receive similar protection through the National Credit Union Administration (NCUA).
If you have more than $250,000 to invest in CDs, you can spread your deposits across multiple banks to ensure full FDIC coverage on all your funds. Some services, like deposit placement networks, automate this process for you.
When Do CDs Make Sense?
CDs are a smart choice in several situations:
- Saving for a known future expense: A down payment on a home, a wedding, or tuition payments due in 1-3 years
- Preserving capital: When you cannot afford to lose any principal, such as with retirement savings you will need soon
- Earning more than a savings account: When you have extra cash beyond your emergency fund that you will not need for a defined period
- Locking in high rates: During periods of elevated interest rates, locking in a multi-year CD can secure that rate even if market rates drop
- Risk-averse investors: For people who prefer guaranteed returns over the uncertainty of stocks and bonds
Tips for Getting the Best CD Rates
- Shop around: Online banks and credit unions often offer significantly higher rates than traditional brick-and-mortar banks
- Compare APY, not just the interest rate: APY accounts for compounding and gives you the true annual return
- Consider credit unions: Many credit unions offer competitive CD rates and lower fees
- Watch for promotional rates: Banks sometimes offer limited-time CD specials with above-market rates
- Negotiate: If you have a large deposit, some banks may offer a better rate upon request
- Set maturity reminders: Mark your calendar before the grace period ends to avoid automatic renewal at a potentially lower rate
