What a Certificate of Deposit Is

A Certificate of Deposit (CD) is a savings product where you give a bank or credit union a lump sum of money for a set period of time — typically three months to five years — in exchange for a fixed interest rate. You agree not to touch that money until the term ends. When the term is up, you get back your original deposit plus the interest you earned.

CDs are different from regular savings accounts. With a savings account, you can withdraw money whenever you want, but the interest rate is usually lower and can change. With a CD, the rate stays the same for the entire term, and you know exactly how much you'll have at the end. The tradeoff is that if you need the money before the term ends, you'll typically pay an early withdrawal penalty.

Banks and credit unions use your CD money to make loans to other customers. That's why they pay you interest — they're borrowing your money for a may provide period. The longer you agree to lock up your money, the higher the interest rate they usually offer.

Key Takeaways

  • You deposit a fixed amount of money for a set term (three months to five years), and the bank pays you a fixed interest rate that does not change.
  • Your money is insured up to $250,000 per depositor per bank through the FDIC (Federal Deposit Insurance Corporation) or NCUA (National Credit Union Administration) if you use a credit union.
  • If you withdraw your money before the term ends, you will pay an early withdrawal penalty that reduces your earnings, sometimes to zero.
  • Interest rates on CDs vary by bank, term length, and current market conditions — shopping around can mean hundreds of dollars in difference over the life of the CD.
  • When your CD term ends, the bank will either return your money and interest or automatically roll it into a new CD at the current rate, depending on your instructions.

How Interest Rates and Terms Work

The interest rate a bank offers depends on three main things: how long the term is, what the current market rates are, and which bank you use. Generally, longer terms pay higher rates. A three-month CD might pay 4.5 percent, while a five-year CD at the same bank might pay 5.2 percent. But this changes constantly as the Federal Reserve adjusts its rates.

The term is the length of time you commit to leaving your money in the CD. Common terms 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. You choose the term when you open the CD, and you cannot change it without paying a penalty.

Interest on a CD is usually compounded — meaning interest is calculated on your original deposit plus any interest already earned. The more often interest is compounded (daily, monthly, or quarterly), the more you earn. A CD that compounds daily will earn slightly more than one that compounds quarterly, even at the same stated rate.

Early Withdrawal Penalties and What They Cost

If you need your money before the CD term ends, you can withdraw it, but the bank will charge you a penalty. The penalty is usually stated as a number of months of interest. For example, a penalty of three months of interest means the bank subtracts three months' worth of what you would have earned.

On a small CD or a short-term CD, the penalty might be just a few dollars. On a large CD or a long-term CD, it can be substantial. If you have a $10,000 CD earning 5 percent annually and the penalty is six months of interest, you lose $250. If you withdraw very early, the penalty might be larger than the interest you've actually earned, meaning you get back less than your original deposit.

Before you open a CD, read the penalty terms carefully. Some banks have lower penalties than others. If you think you might need the money, a shorter-term CD or a regular savings account might be a better choice, even if the rate is lower.

FDIC Insurance and Safety

Money in a CD at a bank is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank. If the bank fails, the FDIC guarantees you'll get your money back, up to that limit. If you have a CD at a credit union, the same protection applies through the National Credit Union Administration (NCUA).

This means if you deposit $50,000 in a CD at Bank A and $50,000 in a CD at Bank B, both are fully insured. But if you deposit $300,000 in a single CD at one bank, only $250,000 is insured. The extra $50,000 is at risk if the bank fails.

CDs are considered one of the safest places to put money because of this insurance and because the rate is fixed and may provide. You know exactly what you'll get back, and the government backs it up.

Shopping for CDs: Rates and Features to Compare

CD rates vary significantly between banks and credit unions. A bank offering 5.0 percent on a one-year CD might be next to one offering 4.2 percent for the same term. Over a year, that difference adds up. On a $10,000 CD, the difference between 5.0 percent and 4.2 percent is $80.

Online banks typically offer higher rates than brick-and-mortar banks because they have lower overhead costs. Credit unions sometimes offer competitive rates to their members. You can compare rates on financial websites that track CD offerings across multiple institutions, or you can call banks directly.

Beyond the rate, compare the penalty terms, the minimum deposit required, and whether the bank automatically renews your CD when the term ends. Some banks let you opt out of renewal so your money just sits in a regular account; others automatically roll it into a new CD at whatever the current rate is. Knowing this in advance prevents surprises.

What Happens When Your CD Matures

When your CD term ends, the bank sends you a notice — usually 10 to 30 days before the maturity date — telling you what will happen next. You have a choice window, usually around seven to ten days, to decide what to do with your money.

Your options are: withdraw the money and close the CD, let it automatically renew into a new CD at the bank's current rate, or move it to a different product like a savings account. If you do nothing and the bank's default is to renew, your money will roll into a new CD. If you want to move your money to a different bank to get a better rate, you need to act before the maturity date.

If you withdraw the money after the term ends, there is no penalty — you get your full deposit plus all the interest earned. The penalty only applies if you withdraw early, before the maturity date.

CDs Versus Other Savings Options

A CD is not the only way to save money. A regular savings account lets you withdraw anytime with no penalty, but the interest rate is usually lower and can change. A money market account is similar to a savings account but sometimes pays slightly higher interest. A high-yield savings account at an online bank can pay rates close to CDs, with the flexibility to withdraw anytime.

If you know you won't need the money for a specific period and want the highest may provide rate, a CD makes sense. If you might need the money sooner or want flexibility, a high-yield savings account might be better. If you're saving for something specific — a down payment, a car, a home repair — and you know when you'll need it, a CD with a term that matches that timeline locks in your rate and protects you from rate drops.

The choice depends on your situation: how long you can leave the money untouched, how much you're saving, and what interest rates are currently available.

Frequently Asked Questions

Can I add money to a CD after I open it?

No. A CD is a fixed deposit. Once you open it, you cannot add more money to that CD. If you want to save more, you would open a separate CD. Some banks let you open multiple CDs at once with different terms.

What if interest rates go up after I buy a CD?

Your rate stays the same for the entire term — that's the point of a CD. If rates rise, you're locked in at the lower rate. When your CD matures, you can open a new one at the higher rate. This is why some people use a CD ladder: they open multiple CDs with different maturity dates so some money matures each year and can be reinvested at current rates.

Do I have to pay taxes on CD interest?

Yes. Interest earned 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, and you report it on your tax return. This is true whether you withdraw the money or let it renew.

What's the difference between a CD and a savings bond?

A CD is issued by a bank or credit union and insured by the FDIC or NCUA. A savings bond is issued by the U.S. Treasury. Both lock up your money for a set term and pay fixed interest, but savings bonds have different tax treatment and are backed by the federal government rather than a bank.

Can I use a CD as collateral for a loan?

Yes. Some banks will lend you money using your CD as collateral, which means you keep earning interest on the CD while borrowing against it. The interest rate on the loan is usually lower than it would be otherwise because the bank has your CD as security. You still cannot withdraw from the CD without paying the early withdrawal penalty.