What Is a Certificate of Deposit (CD)?


When you first start saving money consistently, you probably just transfer the funds into a savings account linked to your checking account. But as that amount grows, it’s time to start thinking about a more robust savings strategy.

certificate of deposit

A traditional savings account provides the least amount of interest possible. Keeping your money in that type of account has its advantages, but it’s not your only option.

One great choice for diversifying your savings is called a certificate of deposit. Also known as a CD, this type of savings account typically offers higher interest rates in exchange for fixed amounts and fixed terms.

Several unique features differentiate CDs from savings accounts and money market accounts. Find out everything you need to know about it to determine how it fits into your savings goal.

You’ll learn more about standard rates and terms, different types of CDs available, and whether it’s right for you. A CD can be a valuable savings tool if you know how it works.

What is a CD?

A certificate of deposit (CD) lets you deposit funds into a bank account, similar to a savings account or money market account. But that’s where the similarities end. The most considerable difference is that a CD involves a timed deposit.

That means instead of withdrawing money as often as you wish, you must keep it there for a predetermined period of time.

The term length varies depending on which account you choose. But, generally speaking, you can expect to earn more the longer you agree to leave your money in the CD.

Your interest rate or annual percentage yield (APY) may be higher if you deposit a larger amount of cash. So if it’s not money you need immediate access to, a certificate of deposit can be a more lucrative way to make your savings work for you.

How do CDs work?

Certificates of deposit (CDs) work by offering savers a higher interest rate in exchange for depositing a fixed amount of money for a set term length. When you invest in a CD, you are essentially lending your money to the bank for a predetermined time frame. In return, the bank agrees to pay you a fixed interest rate, which is typically higher than what you would earn in a traditional savings account.

The term length of a CD can range from one month to ten years, with longer terms typically offering higher interest rates. When you open a CD, you deposit a lump sum of money, which remains in the account until the maturity date. The interest you earn is compounded periodically, often daily, monthly, or quarterly, depending on the CD’s terms and conditions.

At the end of the term, the CD reaches its maturity date, and you have several options. You can withdraw the principal and earned interest, renew the CD for another term, or transfer the funds to another type of account. If you choose not to take any action, most banks will automatically renew the CD for the same term length at the current interest rate.

Keep in mind that most CDs come with early withdrawal penalties if you need to access your money before the maturity date. These penalties can vary depending on the bank and the CD’s term length, but they generally range from three to six months of accrued interest.

How to Open a CD

You can get a CD at just about any bank or credit union. When looking at a credit union, they might refer to them as share certificates. In addition to brick and mortar banks near you, you can also look at online banks to determine the best APY.

It’s also wise to shop around to find the best rate for the term length you’re looking for. The end of a CD term is called its “maturity date,” so keep an eye out for that number when comparing CD accounts.

It’s also worth checking banks and credit unions for a bonus CD rate. Your existing bank may offer a good deal, or you could take advantage of a new customer bonus at a new bank or credit union. When considering any financial product or service, always do your homework before making a decision.

What are the features of a CD?

When researching different certificates of deposit, there are a few other characteristics you should look out for. The first two, which are commonly linked together, are the APY and the term length. Depending on the bank or credit union and the term length, you can expect to find CD rates ranging between 1.00% and 5.00%, with the average rate at about 2.5%.

Terms can range anywhere between one month and ten years, so you have a wide range of options to choose from. There’s also likely a minimum deposit.

Minimum Deposit Requirements

Most banks and credit unions require at least $1,000. However, you may be able to shop around for a lower minimum if you need to. There may also be a maximum, with many accounts capping deposits at $10,000. Of course, you can always spread out extra cash across multiple accounts, especially if you want to vary the term lengths.

Since CDs have a term length, you’ll incur an early withdrawal penalty for withdrawing funds early. The amount is stated in the terms and conditions of your account, usually ranging between three and six months of accrued interest.

Early Withdrawal Penalties

It’s in your best interest to avoid an early withdrawal, so you don’t have to pay withdrawal penalties. That’s why it’s wise to diversify your savings accounts so that you have sufficient funds in more liquid accounts to cover a financial emergency.

For a little more flexibility, some financial institutions offer one free withdrawal throughout the term. Of course, it’s also wise to make sure your CD is insured.

Most banks insure customers’ money through the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per account. Credit unions offer the same protection through the National Credit Union Administration. Deposit insurance is typical with most banks and credit unions, but it’s wise to check.

What types of CDs are available?

While most certificates of deposit have the same characteristics, you can find different types to fit your specific needs. Here’s a brief description of some of the most common types of CDs available today. Browse each one to find the best one for your finances.

Variable Rate CD

A typical CD offers a fixed interest rate, meaning that your money earns the same amount over time. With a variable-rate CD, however, your APY changes based on a broader interest rate. Different banks and credit unions will use different drivers, such as Treasury bills or the prime interest rate.

Your rate would then be whatever the current base rate is plus a certain amount. So if that market rate goes up, you benefit from a higher APY. If it goes down, however, you’ll earn a smaller amount than what you started with. So, it’s a bit riskier than a fixed term but may result in higher returns.

Step Rate CD

For a little more flexibility, consider a step-rate CD. Your account gets to benefit from periodic increases in your interest rate, but you’ll probably be required to start with a higher minimum balance. You may also have the option to withdraw a portion of your funds at the time of each increase without having to pay an early withdrawal penalty fee.

Depending on the account you choose, you may be able to withdraw the entire amount. However, other account types may require you to maintain your original minimum opening balance. The amount of flexibility you need can help you decide on the step rate CD that’s best for you.

Penalty-Free CD

A low-penalty or no-penalty CD gives you the most flexibility but usually comes with restrictions. For example, you might have fewer choices as to the length of the term. Additionally, you’ll probably need a higher deposit amount or be an existing customer at the financial institution. With no-penalty CDs, you’ll likely have a lower rate, but you do get the peace of mind that comes with having more liquid funds.

Callable CD

A callable CD is a unique CD that offers a higher rate but gives the bank the prerogative to end the term at a time of their choosing. So if your CD is no longer financially beneficial for the bank, it becomes “callable.”

Yes, you get a better interest rate. However, you also run the risk of having to find another account for your money earlier than expected. Check the terms and conditions of this CD type to see exactly what it entails.

Market-linked CD

A market-linked CD is a much more sophisticated type of CD. It’s a variable rate CD. Rather than using a specific base rate, like the prime rate, your APY is instead linked to a specific market index.

It’s a riskier type of CD because markets are more difficult to predict than standard interest rates. However, if you’re financially savvy, it’s worth looking into. Just make sure you read all the fine print that comes with your market-linked CD.

What is CD laddering?

Laddering your CDs is an investment strategy that essentially spreads your money out across several accounts and staggers their maturity dates.

The idea of a CD ladder is to open multiple CDs and have one CD account maturing each year. At that time, you can choose what is best to do with it based on your current financial needs. For example, if you need a cash infusion, you can choose to withdraw the funds. On the other hand, if you want to keep the money in a certificate of deposit, you have two options.

The first is to do nothing. That’s because when the CD matures, if you don’t touch it, it automatically renews using the previous terms and conditions. If your previous interest rate is higher than the current rate, then you can let the CD renew itself.

Maximize Your Potential Earnings & Flexibility

Otherwise, your other option is to transfer it into another account that offers better terms. With a CD ladder, your accounts maximize your financial flexibility over time.

By staggering your deposits over several accounts, you can meet the deposit minimums while still maintaining liquid savings elsewhere. Let’s take a look at an example of one way to ladder your certificates of deposit. One way is to pick five accounts ending in one, two, three, four, and five years.

As each account matures, you switch it to a five-year account since that should (in theory) offer a higher rate than the lesser term lengths. Once your fifth account reaches its maturity date, you’ll then be on schedule to have one five-year account maturing each year.

You can then decide whether to renew it or choose another account with a better rate. It’s also a great way to create more liquidity because you have the chance to withdraw every year without incurring a penalty fee.

Is a CD right for you?

There are a few different things to consider when thinking about a CD account. First, make sure you have plenty of other savings available that you can access quickly, easily, and without financial penalty. Most financial experts recommend having at least $500 for an emergency fund. You should also have a few months of expenses to cover yourself during any type of job loss.

After you have that covered, think about your mid-term savings goals. What are you saving up for, and when do you expect to need the money? For example, maybe you’re on a three-year plan to buy a house and have some cash saved up towards your down payment.

If you’re sure you won’t need that money early, then a CD could be a good place to put it for a few years. You could also consider the laddering strategy to maximize your liquidity if you have money set aside for long-term savings goals.

CD Interest Rates

Another factor to consider with CDs today is how competitive the interest rates are. With most accounts offering an APY under 1.0%, they’re not much more competitive than high-yield savings or money market accounts right now.

This is especially true considering the restrictions that come along with long-term CDs. Before the recession and historically low interest rates for saving and borrowing, CDs offered much higher rates.

Now, however, there isn’t much difference in the yield you’ll receive from most bank accounts. However, interest rates are on the rise, which means CDs could be more competitive in the near term.

It’s best to shop around for accounts of all types to make sure you’re getting the biggest bang for your buck. Then, do it again every six months to a year so that you’re evaluating your savings allocations regularly.

Lauren Ward
Meet the author

Lauren is a personal finance writer who strives to equip readers with the knowledge to achieve their financial objectives. She has over a decade of experience and a Bachelor's degree in Japanese from Georgetown University.