How CD interest works

A certificate of deposit earns interest at a fixed rate for a set period. The bank pays you that rate on your full balance, and you cannot withdraw the money before the term ends without paying a penalty. The longer you lock your money away, the higher the rate usually is.

The interest compounds—meaning you earn interest on your interest—but the frequency depends on the bank. Some compound daily, some monthly, some at maturity. Daily compounding gives you slightly more money back, but the difference is usually small on balances under $10,000.

When your term ends, the bank returns your original deposit plus all the interest earned. You then decide whether to withdraw the money, roll it into a new CD at the current rate, or move it elsewhere.

Key Takeaways

  • CD rates vary by bank, term length, and deposit amount, so comparing offers from at least three banks before you commit is worth the time.
  • Longer terms (12 months, 24 months, 60 months) typically pay higher rates than shorter ones (3 months, 6 months), but rates change constantly.
  • You cannot withdraw your money early without losing some or all of the interest you earned, so only lock away money you will not need.
  • The interest you earn is taxable income in the year you receive it, even if you do not withdraw the money until the term ends.

What CD rates look like right now

CD rates change constantly based on what the Federal Reserve does with interest rates. When the Fed raises rates, banks raise CD rates. When the Fed cuts rates, CD rates fall. This means the rate you see today may be different next week.

A 6-month CD at one bank might pay 4.5%, while the same term at another bank pays 3.8%. A 12-month CD often pays more than a 6-month CD at the same bank, but not always—it depends on what the bank thinks rates will do. Online banks typically pay higher rates than brick-and-mortar banks because they have lower overhead costs.

To find current rates, visit the websites of banks you already use, then check online-only banks like Marcus, Ally, or American Express. Most banks list their CD rates on the homepage or in a rates section. Write down the rate, the term, and the minimum deposit required, then compare.

How much interest you actually earn

The amount depends on three things: the rate, the amount you deposit, and how long you leave it there. A $5,000 CD at 4.5% for 12 months earns about $225 in interest. The same $5,000 at 5.5% for 12 months earns about $275. The difference is $50—real money, but not life-changing.

The math is simpler than it looks. Most banks use this formula: (deposit × rate × time in years) = interest earned. So $5,000 × 0.045 × 1 = $225. If your CD compounds more than once a year, the number goes up slightly, but you can use this formula to compare offers quickly.

Longer terms earn more total interest because your money sits there longer, but they also lock you out longer. A $5,000 CD at 5.0% for 24 months earns about $510 total. The same amount at 5.0% for 12 months earns about $250. You earn more, but you cannot touch the money for two years.

Early withdrawal penalties and when they hurt

If you need your money before the term ends, the bank charges a penalty. The penalty is usually a certain number of months' worth of interest. A 12-month CD might have a 6-month interest penalty, meaning if you withdraw after 3 months, you lose 6 months of interest and get back only your deposit.

On a small CD, this might cost you $20 or $30. On a larger one, it could cost hundreds. Some banks have lower penalties—3 months of interest instead of 6—so ask before you open the account. A few banks offer "no-penalty CDs" that let you withdraw early with no penalty, but they pay lower rates to make up for it.

The penalty is why you should only put money into a CD if you are confident you will not need it. If you might need the cash in the next 6 months, keep it in a savings account instead, even if the rate is lower.

CDs versus savings accounts and money market accounts

A savings account lets you withdraw money anytime without penalty, but it pays a lower rate—usually 0.5% to 2.0% depending on the bank. A CD locks your money away but pays more—usually 4.0% to 5.5% right now. The trade-off is flexibility for a higher return.

A money market account sits in the middle. It pays more than a savings account but usually less than a CD, and it lets you write checks or make withdrawals, though there are limits. If you need some access to your money but want a better rate than savings, a money market account is worth comparing.

For money you will definitely not touch for 12 months or longer, a CD almost always wins on rate. For money you might need in the next 3 to 6 months, a savings account is safer. For money you need partial access to, a money market account is the middle ground.

Taxes on CD interest

The interest you earn on a CD is taxable income. If you earn $225 in interest, you owe income tax on that $225 in the year the interest is credited to your account—not when you withdraw the CD. The bank will send you a 1099-INT form in January showing how much interest you earned.

This matters most if you have a large CD or multiple CDs. A $50,000 CD earning 5.0% generates $2,500 in taxable interest per year. If you are in the 22% tax bracket, that costs you about $550 in federal tax. Plan for this when you decide how much to put into a CD.

If you have a CD in a retirement account like an IRA, the interest is not taxed until you withdraw from the IRA. This is one reason some people use CDs inside IRAs—the tax is deferred.

How to choose a CD term that fits your timeline

Match the CD term to when you will actually need the money. If you are saving for a down payment in 18 months, a 12-month CD gets you close, but a 24-month CD locks you out too long. If you are saving for a goal 5 years away, a 60-month CD makes sense.

Shorter terms (3 to 6 months) pay lower rates but let you move your money if rates rise. Longer terms (24 to 60 months) pay higher rates but lock you in if rates fall. There is no perfect choice—it depends on what you think rates will do and when you need the cash.

One strategy is to open multiple CDs with different term lengths—a "CD ladder." You might open a 12-month, a 24-month, and a 36-month CD with the same amount in each. As each one matures, you decide whether to roll it over or withdraw. This gives you some flexibility while still earning higher rates than a savings account.

Frequently Asked Questions

Can I lose money in a CD?

No. Your deposit is insured by the FDIC up to $250,000 per bank, so you will get your money back. You can only lose interest if you withdraw early and the penalty exceeds what you earned. For example, if you earn $100 in interest but the penalty is $150, you get back your deposit minus $50.

What happens when my CD matures?

The bank notifies you before the term ends, usually 7 to 10 days before. You then have a window (often 7 to 10 days) to decide what to do. You can withdraw the money, roll it into a new CD at the current rate, or move it to another account. If you do nothing, most banks automatically roll it into a new CD at the current rate.

Do I have to put in a minimum amount?

Most banks require a minimum deposit to open a CD, usually $500 to $2,500. Some online banks have lower minimums or no minimum at all. Check the bank's website or call before you open an account.

Is a CD a good place to keep an emergency fund?

No. An emergency fund needs to be accessible immediately, and a CD charges a penalty if you withdraw early. Keep your emergency fund in a savings account or money market account instead. Use CDs only for money you will not need for several months or longer.

What if rates go up after I open my CD?

You are locked into your rate for the full term. If rates rise, you earn less than you could have. This is the risk of locking money away. If rates fall, you benefit because you locked in the higher rate. This is why some people use CD ladders—it lets you take advantage of rate changes as CDs mature.