A CD locks your money away for a set time in exchange for a fixed interest rate

A certificate of deposit (CD) is an agreement between you and a bank. You give the bank a lump sum of money, the bank promises to pay you a specific interest rate, and you agree not to touch that money until a date the bank sets. When that date arrives—called the maturity date—you get your original money back plus the interest earned.

The bank uses your money during that time. In return, it pays you more interest than you would earn in a regular savings account. The longer you lock your money away, the higher the rate usually is. A 3-month CD pays less than a 12-month CD, which pays less than a 5-year CD.

CDs are FDIC insured at most banks, meaning if the bank fails, the federal government protects your deposit up to $250,000. This makes them one of the safest places to keep money that you know you won't need soon.

Key Takeaways

  • You deposit a fixed amount, lock it for a set period (3 months to 5 years or longer), and receive a may provide interest rate that does not change.
  • If you withdraw money before the maturity date, the bank charges an early withdrawal penalty that reduces your earnings or principal.
  • CD rates vary by bank, term length, and deposit amount, so comparing offers across institutions can add hundreds of dollars to your return.
  • When your CD matures, you can withdraw the money, open a new CD, or let it roll over into another CD at the bank's current rate.

How the interest rate and term length work together

When you open a CD, the bank tells you two things: the annual percentage yield (APY) and the term. The APY is the rate you will earn, expressed as a yearly percentage. A 5.00% APY on a $10,000 CD held for one year means you will earn $500 in interest (before taxes).

The term is how long your money stays locked in. Common terms are 3 months, 6 months, 1 year, 2 years, 3 years, and 5 years. Some banks offer 10-year CDs or very short 30-day CDs. The longer the term, the higher the APY usually is, because the bank has your money for longer and can lend it out for longer periods.

The interest compounds, meaning you earn interest on your interest. How often it compounds—daily, monthly, or quarterly—depends on the bank's terms. More frequent compounding means slightly more money at the end, but the difference is usually small.

What happens if you need the money before maturity

If you withdraw money from a CD before the maturity date, the bank charges an early withdrawal penalty. This penalty is a set number of months of interest that you forfeit. A CD with a 6-month penalty means you lose 6 months' worth of the interest you would have earned.

The penalty comes out of your interest first. If your penalty is larger than the interest you have earned so far, the bank takes the difference from your principal—the original amount you deposited. This means you can end up with less money than you started with, even though you earned interest.

Before opening a CD, read the disclosure document to find the exact penalty. A 1-year CD at one bank might have a 3-month penalty, while another bank charges 6 months. Over a $10,000 deposit, that difference could be $100 or more. Some banks offer no-penalty CDs with lower rates but no early withdrawal fee, which is worth considering if you are unsure about keeping the money locked away.

Comparing CD rates across banks

CD rates change constantly and vary widely between banks. On the same day, one bank might offer 4.75% on a 1-year CD while another offers 5.25%. Over a year, that 0.50% difference means $50 more per $10,000 deposited.

Online banks typically offer higher rates than brick-and-mortar banks because they have lower overhead costs. Credit unions sometimes offer competitive rates as well, especially if you are a member. Large national banks often have the lowest rates because they spend more on marketing and branch locations.

To find the best rate, check multiple banks' websites or use a rate comparison tool. Look at the APY, the term, the minimum deposit required, and the early withdrawal penalty. Write down the top three options and compare them side by side. The highest rate is not always the best choice if the penalty is harsh or the minimum deposit is too high for your situation.

What happens when your CD matures

On the maturity date, your CD stops earning interest. The bank sends you a notice a few weeks before, telling you what happens next. You have three main options: withdraw the money, open a new CD, or let it roll over.

If you do nothing, most banks automatically roll over your CD into a new one with the same term at the bank's current rate. This happens within a few days of maturity. If rates have dropped, you will earn less on the new CD. If rates have risen, you will earn more. You usually have a grace period—often 7 to 10 days—to cancel the rollover and withdraw the money instead, so check your mail and your online account around the maturity date.

If you want to move your money to a different bank for a better rate, do it during the grace period. Once the rollover happens, you will face an early withdrawal penalty if you take the money out before the new CD matures. Some people set a calendar reminder on their maturity date to avoid missing the window.

How CDs fit into a savings strategy

CDs work best for money you know you will not need for a specific amount of time. If you have a down payment goal for a house in 3 years, a 3-year CD locks in a rate and removes the temptation to spend the money. If you have an emergency fund already in place and extra cash sitting in a low-rate savings account, moving some of it to a CD can earn you more without taking on risk.

Some people use a CD ladder to balance safety with flexibility. You buy multiple CDs with different maturity dates—one that matures in 1 year, one in 2 years, one in 3 years, and so on. As each one matures, you can decide whether to spend the money or roll it into a new longer-term CD. This way, you are not locking all your money away for the same length of time.

CDs are not a substitute for an emergency fund. Emergency money should stay in a regular savings account where you can access it without penalty. CDs are for money you have already set aside for a specific goal and can afford to leave untouched.

Understanding CD terms and conditions before you open one

Before you deposit money, the bank must give you a disclosure document that explains the CD's terms. This document lists the APY, the term, the minimum deposit, the compounding frequency, the maturity date, and the early withdrawal penalty. Read it carefully, because the penalty is where most people get surprised.

Some CDs have step-up rates, meaning the interest rate increases at set points during the term. A 5-year CD might start at 4.50% for the first year, then jump to 4.75% for the next two years, then 5.00% for the final two years. These can be worth it if you expect rates to stay flat or fall, but they usually start lower than a standard CD.

Ask the bank whether the CD is FDIC insured and up to what amount. Most are insured up to $250,000 per depositor per bank. If you have more than $250,000, you can open CDs at different banks to stay within the insurance limit, or look into CD brokerage accounts that spread your money across multiple banks automatically.

Frequently Asked Questions

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

No. A CD is a fixed contract. You deposit the full amount upfront, and you cannot add to it later. If you want to save more money, you would need to open a separate CD or use a regular savings account.

What if I need the money in an emergency?

You can withdraw it, but you will pay the early withdrawal penalty. Calculate whether the interest you have earned so far is enough to cover the penalty. If not, you will lose money. For true emergencies, an emergency fund in a regular savings account is better than a CD.

Are CDs taxed?

Yes. The interest you earn on a CD is taxable income in the year you earn it, even if you do not withdraw the money. The bank will send you a 1099-INT form at tax time showing how much interest you earned. This is one reason CDs in retirement accounts like IRAs can be useful—the interest grows tax-deferred.

Should I buy a CD if interest rates are falling?

If you believe rates will drop, locking in a current rate with a CD makes sense. If you think rates will rise, a shorter-term CD lets you reinvest at a higher rate sooner. No one can predict rates perfectly, so many people split the difference with a CD ladder.

What is the difference between a CD and a savings account?

A savings account has no maturity date and no penalty for withdrawal, but it earns much less interest. A CD earns more but locks your money away. Use a savings account for money you might need soon, and a CD for money you can leave alone.