What Is a CD (Certificate of Deposit)? (2024)

In a nutshell

A CD is a bank deposit product that offers a fixed interest rate for the duration of its term.

• Investors looking for a safe investment that offers higher returns than a savings account often turn to certificates of deposit (CDs).
• Terms generally range from 30 days to five years, with numerous intervals in between. In this article, we'll define how a CD works, discuss if they're a good investment, and share where to get one.

How does a CD work?

A CD is a contract between a customer and a bank where the money is locked in for a specific timeframe. The bank agrees to pay the customer a set interest rate for the duration of the CD, regardless if rates go up or down. In exchange for this guaranteed interest rate, the customer agrees that they’ll pay an early termination fee in case they break the contract and withdraw their money early.

When the CD matures, the customer may withdraw their money or renew it at the prevailing interest rates. Depending on the interest rate environment, rates could be higher or lower. Banks typically notify the customer that the CD term is expiring and notify them of their options — withdraw, add money, or do nothing. If the customer does not respond or chooses to do nothing, the CD is reinvested at the same term and current interest rates.

Interest earned from the CD typically is deposited into a linked bank account. This is a good option for retirees who seek recurring income from their investments. Those who don’t need the money often direct the interest payments to a savings account to earn additional interest.

How are CD rates determined?

CD rates are set by banks that use the current interest rate environment, the length of its term, and the bank's funding needs. Banks tend to follow the overall interest rate environment and adjust their rates up and date based on the Fed Funds Rate. Interest rates are also determined by the length of the CD's term and government bonds of similar duration. Most importantly, banks adjust their CD rates based on their funding needs. If they want more deposits, they'll scale rates upwards to get deposits from competitors, or vice versa if they are flush with cash.

CD vs. savings accounts vs. money market accounts

If you're looking to earn interest on your bank deposits, you generally have three options – CDs, savings accounts, and money market accounts. Each of these products serves a distinct purpose and can be a good choice in the right circ*mstances.

Here's how to tell the difference between these three bank products.

Certificates of deposit

CDs are timed deposits where you'll receive a fixed interest rate for the duration of your term. When the CD matures, it renews for the same term at the prevailing rates. If you need access to your money before it matures, most banks charge a penalty of up to six months of interest.

Savings accounts

A savings account offers safety for your money while earning a modest amount of interest. Although you can often find high-yield savings accounts at online banks. You may have a maximum of six external transactions with savings accounts per month, so they should not be used as a primary banking account.

Money market accounts

Money market accounts are a blend between a checking account and a savings account. It earns a higher rate of interest while allowing an unlimited number of transactions, including the ability to write checks at some banks. Money market accounts often have higher minimum balance requirements or monthly fees compared to savings accounts.

Are CDs safe?

Yes, CDs are a safe place to store your money. FDIC coverage protects your CDs and other deposit balances up to $250,000 at each bank. If the bank fails, your deposits are guaranteed up to $250,000. Recovery for any amounts above that are not guaranteed and are dependent upon the bank's assets and liabilities.

It is possible to increase this coverage based on the way the account is titled. For example, you can have two CDs at one bank — one solely under your name and one held jointly with your spouse — and both would be covered up to $250,000.

Are CDs a good investment?

Pros

• Guaranteed return: Your interest rate is guaranteed through the end of the CD’s term, even if current rates drop. This safety helps to balance out the uncertainty of other investments.
• FDIC insurance: CDs are insured for up to $250,000 in case the bank goes out of business. This $250,000 limit is based on your combined balance at the bank, but this coverage can be increased based on how you title your accounts.
• Ability to ladder CDs: Some customers ladder their CDs so that they mature every few months. This provides liquidity in case of an emergency while still benefiting from higher rates offered to longer-term CDs.
• Relationship pricing: Banks value customers that have larger balances and often include CDs in relationship pricing benefits. You may qualify for waived fees, better rates and terms, and other benefits based on your combined balances.

Cons

• Low returns: Because CDs are so safe, they generally offer rates below stocks, bonds, and other investments.
• Fixed interest rate: CDs lock in interest rates for the duration of their term. In a rising interest rate environment, your relative earning power is decreasing compared to other options.
• Locked duration: Your money is locked into a CD until it matures at the end of its term. You may miss out on other opportunities while your money is tied up.
• Early withdrawal penalties: If you need to access your money before the CD matures, you’ll be charged an early withdrawal penalty. The penalty is based on the length of the term and can be up to six months of interest.

Types of CDs

There are many different types of CDs for investors to choose from. Most banks offer a variety of terms to choose from. Additionally, some banks offer CDs with special features that can make them attractive, even if the rate is lower.

Common CD terms

Investors choose a variety of CD terms to suit their liquidity needs, goals, and other factors. These are the most common lengths of CD terms:

• 1 month.
• 2 months.
• 3 months.
• 6 months.
• 9 months.
• 12 months.
• 24 months.
• 36 months.
• 48 months.
• 60 months.

Some banks offer special terms that fit their funding needs. For example, you might find a 4-month, 23-month, or 30-month when reviewing CD options.

Promotional CDs

In addition to the term of a CD, some banks offer different promotions to encourage investors to purchase a CD. These are a few of the CD promotions that you might encounter when shopping for a CD:

• Bump-up CD: Investors benefit from rising interest rates with the option to bump up the interest rate. Customers must request the adjustment and generally can only do this once per term.
• Step-up CD: This CD also adjusts in a rising rate environment, but it is done automatically by the bank at certain intervals throughout the term of the CD.
• Liquid CD: Most CDs charge a penalty if you withdraw before it matures. A liquid CD allows you to withdraw money before maturity without penalty.
• Zero-coupon CD: Instead of receiving regular interest payments, a zero-coupon CD is purchased at a discount and matures at face value. This is similar to a zero-coupon bond. Keep in mind that you'll still owe taxes on the interest earned, even though you won't receive it until the CD matures.
• Callable CD: The bank may call your CD before its maturity date and reissue it at the current, lower interest rate. Callable CDs often provide higher interest rates due to the risk of the bank calling your CD before it matures.
• Jumbo CD: These CDs require larger deposits and often pay a higher interest rate than CDs without a minimum deposit requirement.
• Add-on CD: With an add-on CD, you can add more money to your initial deposit to earn the same locked-in interest rate. Most banks limit the number or frequency of additional deposits, so verify the bank's limits before buying one.

Where can I get a CD?

If you’re interested in opening a CD for your portfolio, there are numerous places where you can open a CD and lock in an interest rate. Here are a few of the most common places to get a CD.

• Local bank branch: Visit your local bank branch, and a banker will be able to open a CD for you. Before opening, it is best to compare rates among several banks to ensure that you’re getting the best rates.
• Online banks: Comparing CD rates online is simple and quick. Most online banks allow you to open an account within minutes to lock in their best rates. Aggregation sites make it easy to compare rates from several banks and choose the one that best fits your needs.
• CDARs (Certificate of Deposit Account Registry Service): These accounts are offered by various financial institutions and enable investors to insure more than the $250,000 FDIC limits by spreading their deposits among several banks.
• Brokerage firm: Some brokerage firms allow customers to purchase CDs to balance out their portfolios. The brokerage firm does not offer the CDs that it sells. Instead, they deposit the money into accounts at their respective banks. Purchasing a CD using this route allows an investor to see all of their assets on one statement.

How much do I need to open a CD?

Minimum deposit amounts vary by bank. Many banks do not have a minimum deposit requirement when opening a CD, so it is possible to open one with a small deposit.

However, some banks require minimum deposits of $1,000, $100,000, or more in order to open a CD or earn their best rates. You can find out the minimum deposit amounts for most banks by reviewing their website or calling a local branch.

Aggregation sites also compile this information. However, it may not always be up to date. Before attempting to open a CD, verify the bank’s requirements to avoid wasting your time.

What if I need to withdraw my money early?

Banks expect to have CD funds available to them throughout the duration of the term. If you withdraw money before the CD matures, most CDs charge a penalty. The early withdrawal penalty usually depends on how long the CD’s term is.

Every bank is different, but common early withdrawal penalties are:

• Terms under 12 months: CDs with terms under one year generally have a penalty of three months’ interest.
• Terms of 12 months and greater: For CDs with terms of one year or longer, the early withdrawal penalty is usually six months’ interest.

The early withdrawal penalty is charged even if you haven’t earned enough interest to offset the fees charged. Because of this, when you terminate the CD early, it is possible that you’ll receive less than your original deposit.

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CDs can be a good choice for investors who want to earn a guaranteed rate of return yet don't need access to their money before the term expires. You can buy CDs at a variety of terms that match your timeframe, ranging from 30 days to five years.

Some CDs have extra features that provide additional flexibility or benefits, which make them attractive to investors. If you're interested in purchasing a CD, you have many options, including your local bank branch or an online bank.