What a certificate of deposit actually is
A certificate of deposit (CD) is an agreement between you and a bank: you give the bank a lump sum of money, the bank holds it for a set period of time, and at the end of that period you get your money back plus interest. The bank pays you more interest on a CD than it would on a regular savings account because you are promising not to touch the money until the term ends.
The key difference from a savings account is the lock-in period. With a savings account, you can withdraw money whenever you want. With a CD, you agree to leave the money untouched for a specific length of time—three months, six months, one year, five years, or longer depending on what the bank offers. If you withdraw the money before that time is up, the bank charges you a early withdrawal penalty, which is a fee that reduces how much you get back.
CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per account, the same as regular savings accounts. This means if the bank fails, your money is protected.
Key Takeaways
- You deposit a fixed amount of money for a fixed period of time, and the bank pays you a set interest rate that does not change during the term.
- The interest rate on a CD is higher than on a savings account because you cannot withdraw the money early without paying a penalty.
- The penalty for early withdrawal varies by bank and by CD term—some banks charge three months of interest, others charge a percentage of the balance.
- When your CD matures (the term ends), you can withdraw the money and interest, open a new CD, or let the bank automatically renew it into another CD at the current rate.
- CDs work best for money you know you will not need for several months or years and want to earn a may provide return on.
How the interest rate works on a CD
When you open a CD, the bank tells you the annual percentage yield (APY) you will earn. This is the actual return you get per year, including any compounding. Unlike a savings account where the rate can change, a CD rate is locked in for the entire term. If you open a one-year CD at 4.5% APY, you will earn 4.5% on your money for the full year, even if the bank lowers its rates the next month.
The longer the term, the higher the rate usually is. A six-month CD might pay 3.8% APY, while a five-year CD might pay 4.8% APY. This is because the bank wants to keep your money longer and is willing to pay more for that certainty. However, this is not a rule—rates depend on what the bank decides and what is happening in the broader economy.
Interest on a CD is usually compounded daily or monthly, meaning the interest you earn gets added to your balance, and then you earn interest on that interest. The bank calculates the final amount and deposits it into your account when the CD matures.
What happens when your CD reaches maturity
When your CD term ends, the bank sends you a notice (usually 10 to 14 days before the maturity date) telling you what will happen next. You have three main options: withdraw the money, open a new CD, or do nothing and let the bank automatically renew the CD.
If you withdraw, the bank deposits your original deposit plus all the interest you earned into your linked checking or savings account. You can then use that money however you want. If you open a new CD, you start a fresh term at whatever rate the bank is currently offering—which may be higher or lower than your previous CD. If you do nothing, many banks automatically roll your CD into a new one at the current rate, though some require you to opt in to this renewal.
The automatic renewal option is important to watch. If you do not want to renew and the bank automatically does it anyway, you usually have a grace period (often 7 to 10 days) to withdraw the money without penalty. After that grace period ends, you are locked in again.
Understanding early withdrawal penalties
If you need your money before the CD matures, you can withdraw it, but the bank will charge you a penalty. The penalty amount varies widely by bank and by the CD term. Some banks charge a flat fee (like $25), others charge a percentage of your balance (like 1%), and others charge a certain number of months of interest (like three months of interest earned).
A longer-term CD usually has a larger penalty than a shorter-term one. A three-month CD might have a penalty of one month of interest, while a five-year CD might have a penalty of six months of interest. Before you open a CD, the bank must disclose the penalty in writing, so you know exactly what you will owe if you withdraw early.
The penalty comes out of your balance. If you have a $5,000 CD earning $100 in interest and the penalty is $50, you get back $5,050 (the original $5,000 plus $50 of the interest you earned). The penalty does not come out of your pocket beyond what you already deposited.
CD ladders and how they work
Some people use a strategy called CD laddering to balance earning higher rates with having regular access to their money. Instead of putting all your money into one long-term CD, you split it into several CDs with different maturity dates.
For example, you might open five $1,000 CDs: one with a one-year term, one with a two-year term, one with a three-year term, one with a four-year term, and one with a five-year term. Every year, one CD matures. You can then withdraw that money if you need it, or open a new five-year CD to replace it. This way, you earn the higher rates that longer-term CDs offer, but you also have money becoming available every year.
Laddering works best if you have a larger amount to invest and want to keep some flexibility. It requires more attention than a single CD because you have to decide what to do with each one as it matures.
CDs versus savings accounts and money market accounts
The main trade-off with a CD is rate versus flexibility. A CD pays more interest than a regular savings account because you cannot touch the money. A savings account lets you withdraw anytime with no penalty, but the interest rate is lower and can change at any time.
A money market account sits in the middle. It usually pays more than a savings account but less than a CD, and it lets you withdraw money (though often with limits on how many withdrawals you can make per month). Money market accounts are useful if you want a higher rate but also want some access to your cash.
Choose a CD if you have money you know you will not need for several months or longer. Choose a savings account if you want to keep your money accessible. Choose a money market account if you want something in between.
How to open a CD
Opening a CD is straightforward. You visit a bank's website or branch, choose the term length and deposit amount you want, and provide the bank with your personal information (name, address, Social Security number, and so on). The bank verifies your identity and opens the account.
You can fund the CD by transferring money from another account at the same bank, transferring from an account at a different bank, or depositing cash or a check at a branch. The bank will tell you which methods are available and how long each takes to process.
Once the CD is open, you do not do anything else until it matures. The bank holds the money, calculates the interest, and notifies you when the term is ending. You do not need to make deposits or withdrawals during the term (and you cannot without paying a penalty).
Frequently Asked Questions
Can I withdraw money from a CD before it matures?
Yes, but you will pay an early withdrawal penalty. The penalty amount depends on the bank and the CD term—it might be a flat fee, a percentage of your balance, or a number of months of interest. The bank discloses the penalty before you open the CD, so you know the cost upfront.
What is the difference between APY and interest rate?
APY (annual percentage yield) is the actual return you get per year, including compounding. The interest rate is the base rate before compounding is factored in. Banks are required to show you the APY, which is the number that matters for comparing CDs.
What happens if the bank fails?
Your CD is insured by the FDIC up to $250,000. If the bank fails, the FDIC pays you your deposit plus all interest earned up to the maturity date, even if the bank no longer exists. This protection is the same as for regular savings accounts.
Can I move a CD to a different bank?
You can withdraw your money when the CD matures and open a new CD at a different bank. You cannot transfer a CD directly to another bank before it matures without triggering an early withdrawal penalty. Some banks offer CD rollovers where they help you move the money, but this still counts as a withdrawal and may incur a penalty.
What happens if I do not do anything when my CD matures?
Many banks automatically renew your CD into a new term at the current interest rate. You usually have a grace period (often 7 to 10 days) to withdraw the money without penalty if you do not want the renewal. Check your bank's policy and watch for the maturity notice so you can make a decision before the renewal happens automatically.