What a certificate of deposit is and how it works
A certificate of deposit (CD) is a savings account where you agree to leave money untouched for a set period — usually three months to five years — in exchange for a fixed interest rate. The bank or credit union pays you that rate for the entire term, regardless of whether market rates rise or fall. When the term ends, you get your principal back plus the interest earned.
CDs are different from regular savings accounts because the rate does not change and you cannot withdraw the money early without paying a penalty. That penalty is typically a loss of some or all of the interest you would have earned. The tradeoff is that you know exactly how much money you will have at the end, which makes CDs useful for money you do not need to access right away.
CDs are insured by the Federal Deposit Insurance Corporation (FDIC) if held at a bank, or by the National Credit Union Administration (NCUA) if held at a credit union. That means your money is protected up to $250,000 per account owner, per institution. This protection applies even if the bank fails.
Key Takeaways
- CD rates vary by term length, bank, and current market conditions, so comparing rates across multiple institutions can add hundreds of dollars to your return.
- Shorter terms (three to six months) have lower rates but let you move your money sooner; longer terms (three to five years) pay more but lock your money away.
- Early withdrawal penalties can erase most or all of your interest, so only put money in a CD if you will not need it before the term ends.
- Online banks typically offer higher rates than brick-and-mortar banks because they have lower overhead costs.
- You can ladder CDs by buying multiple CDs with different maturity dates, which gives you access to some money each year while keeping rates competitive.
How CD rates are set and what affects them
CD rates are set by each bank or credit union and are not regulated by the government. Banks decide their rates based on the current federal funds rate (the rate the Federal Reserve sets for banks to lend to each other), their own funding needs, and what competitors are offering. When the Federal Reserve raises rates, banks usually raise CD rates within weeks. When the Fed cuts rates, CD rates fall more slowly.
The term length is the biggest factor in the rate you receive. A six-month CD will pay less than a one-year CD at the same bank. A five-year CD will pay more than a one-year CD. This is because the bank is borrowing your money for longer and wants to compensate you for tying it up. The difference between short-term and long-term rates is called the yield curve. When the yield curve is steep, longer terms pay significantly more. When it is flat, the difference is small.
The type of institution matters too. Online banks usually offer higher rates than traditional banks because they do not have the cost of physical branches. Credit unions sometimes offer competitive rates to their members. Banks in areas with high competition for deposits often raise rates faster than banks in areas with less competition.
Comparing CD rates across banks and credit unions
The best way to find a high-rate CD is to check multiple institutions. Start with online banks, which typically have the highest rates. Then check your current bank, your credit union if you belong to one, and any regional banks in your area. Write down the rate, the term, and any special conditions (like whether you can add money during the term, or whether the rate is promotional and will drop after a certain period).
Pay attention to whether a rate is a promotional rate or a standard rate. Promotional rates are often higher but apply only to new money or new customers. After the promotional period ends, the rate drops to the standard rate. Read the fine print to see how long the promotional rate lasts.
Also check the early withdrawal penalty. Some banks charge a flat fee (like $25). Others charge a number of months' interest (like three months' interest on a one-year CD). A CD with a slightly lower rate but a lower penalty might be better if you think there is any chance you will need the money early. Compare the penalty across institutions — it varies widely.
CD terms and what each one means for your money
CDs come in many term lengths. The most common are three months, six months, one year, two years, three years, and five years. Some banks offer terms as short as one month or as long as ten years, but these are less common.
Shorter terms (three to six months) have lower rates but let you reassess your options more often. If you think rates might rise soon, a short-term CD lets you reinvest at a higher rate when it matures. Longer terms (three to five years) lock in a higher rate but commit your money for years. If rates fall after you buy a CD, you are protected by the higher rate. If rates rise, you are stuck with the lower rate unless you pay the early withdrawal penalty.
The term you choose depends on when you will need the money and what you think will happen to rates. If you are saving for something specific that will happen in two years, a two-year CD makes sense. If you do not know when you will need the money, a shorter term gives you more flexibility.
CD laddering: spreading your money across multiple terms
One way to get both higher rates and regular access to your money is to build a CD ladder. This means buying multiple CDs with different maturity dates. For example, you might buy five one-year CDs, each maturing in a different year. Each year, one CD matures and you can either withdraw the money or reinvest it in a new five-year CD.
Laddering works because you get the higher rates of longer-term CDs while still having money available each year. If rates rise, you can reinvest the maturing CD at the new higher rate. If rates fall, you still have the older CDs earning the higher rate you locked in earlier. Laddering requires enough money to buy multiple CDs and the discipline to reinvest each time one matures, but it is a common strategy for people with substantial savings.
To build a ladder, divide your money by the number of rungs you want. If you have $50,000 and want a five-year ladder, you would buy five $10,000 CDs maturing in one, two, three, four, and five years. Each year, reinvest the maturing CD in a new five-year CD. Over time, you will have five five-year CDs all earning the highest rate, with one maturing each year.
Early withdrawal penalties and when they apply
If you withdraw money from a CD before the term ends, the bank charges an early withdrawal penalty. The penalty is deducted from your interest or principal. Some banks will charge a penalty even if you only withdraw part of the money.
Penalties vary widely. Some banks charge a flat fee ($25 to $50). Others charge a number of months' interest — for example, three months' interest on a one-year CD, or six months' interest on a five-year CD. A few banks charge a percentage of the principal. Read the CD's terms before you buy to know what the penalty is.
The penalty can be large enough to erase all your interest and eat into your principal. For example, if you buy a five-year CD at 4.5% and withdraw after six months, a six-month interest penalty might cost you more than you earned. This is why CDs are only right for money you are certain you will not need before the term ends.
Where to buy CDs and what to watch for
You can buy CDs at banks, credit unions, and through brokerage firms. Most people buy them directly from a bank or credit union website. You can also buy CDs through a brokerage account, which sometimes offers access to CDs from multiple banks in one place.
When you buy a CD, make sure the institution is FDIC-insured (if it is a bank) or NCUA-insured (if it is a credit union). You can check FDIC insurance status on the FDIC website by searching for the bank's name. This protects your money up to $250,000 if the institution fails.
Watch for CDs that require a minimum deposit. Many banks require $500 to $2,500 to open a CD. Some online banks have lower minimums. If you have a small amount to save, look for banks with low or no minimums.
Also check whether the CD allows you to add money during the term. Some CDs let you make additional deposits at the same rate. Others lock the rate and amount from day one. If you think you will have more money to save during the term, look for a CD that allows additions.
Frequently Asked Questions
Can I withdraw money from a CD before it matures?
Yes, but you will pay an early withdrawal penalty. The penalty is set by the bank and is deducted from your interest or principal. The penalty can be large enough to wipe out all your earnings, so only withdraw early if you have no other option. Some banks offer "no-penalty CDs" with lower rates but no early withdrawal fee.
What happens when my CD matures?
When the term ends, the bank deposits your principal plus interest into your account. You then have a grace period (usually seven to ten days) to decide what to do with the money. You can withdraw it, move it to another account, or reinvest it in a new CD. If you do nothing, most banks automatically roll the money into a new CD at the current rate.
Are CDs taxed?
Yes. The interest you earn on a CD is taxable income. The bank will send you a 1099-INT form at the end of the year showing how much interest you earned. You report this on your tax return. The interest is taxed at your ordinary income tax rate, not at the capital gains rate.
Is my money safe in a CD?
Yes, if the bank or credit union is FDIC or NCUA insured. Your money is protected up to $250,000 per account owner, per institution. If the bank fails, the FDIC or NCUA will return your money. This protection covers the principal and all accrued interest.
Should I buy a CD or keep money in a savings account?
A CD pays more interest than a savings account, but your money is locked away. A savings account lets you withdraw anytime without penalty but pays less. If you do not need the money for several months or longer, a CD usually pays more. If you might need the money soon, a high-yield savings account is more flexible.