What is a CD (certificate of deposit)? (2024)

As you look for ways to grow your savings, certain accounts can give you the upper hand. A certificate of deposit (CD) can offer you a higher interest rate on those savings, as long as you won't need the cash for several months or longer. Getting a full grasp of a CD's features can help you decide if it's the right account to push your goals forward.

We'll cover these topics:

• What is a CD?
• How does a CD work?
• When does a CD mature?
• Are CDs FDIC-insured?
• Who should consider opening a CD?
• Savings accounts vs. CDs: How do they compare?
• What are the different types of CDs?
• What are the risks of a CD?
• What's a CD ladder?
• CD FAQs
• Should I open a CD?

Financial institutions use the money you deposit in your savings accounts to make loans to other customers. At the same time, a bank has no way of knowing when someone might need to withdraw all of their money from an account, leaving the bank with less to lend. To protect against that possibility, manybanks also offer CDs, aka timed deposits. When you open a CD, you're telling the bank that you'll leave the money in the account for the duration of the term.

With the bank reassured that the money will be there, it usually can offer you a higher interest rate. CD interest rates are based on the rates set by the Federal Reserve, your deposit amount and the term length. Usually, the longer the term, the higher the interest rate. The APY — orannual percentage yield— will also play a role in how hard your interest rate works for you. It accounts for the total interest you'll earn on the CD in one year, including the base interest rate and how that interest will compound over time.

You can take the money out of your CD before the term ends — known as its maturity date — but doing so will cost you. The penalty can vary by bank but may be several month's worth of interest or a specific fee.

When you open a CD, you choose the term length. At the end of the term, the CD reaches its maturity date and you can withdraw your original deposit plus the interest it's earned.

The term length that works for you depends onwhen you'll need to access your cashand the interest rates available. Terms can vary by bank, but some common options include:

• Six months
• 10 months
• 12 months
• 14 months
• 18 months
• 24 months
• 60 months

If rates are low, you may not want to pick a CD that will mature several years from now, as rates may go up in that time and you could miss out. You can always renew the CD at the end of the term. When you renew, you get a new interest rate, which may be higher than the initial rate.

When rates are high, choosing a CD that matures in a few years can make sense as long as you don't expect to need the cash before then. The interest is fixed, so the CD will earn the same rate right up until maturity.

Most CDs compound interest, which means the interest the deposit earns gets added to the original deposit amount and starts to earn interest itself. With compounded interest, your deposit earns more money faster.

The Federal Deposit Insurance Corporation (FDIC) insures CDs up to $250,000. That means if the bank goes under, you won't lose your savings (of up to $250,000).

The $250,000FDIC insurancelimit is per bank, per depositor and per account ownership category — whether it's a single account, joint account, trust account or others. So you can open CDs at several banks and have them each covered up to $250,000 by the FDIC. But if you have a savings account, checking account and CD at one bank, the $250,000 coverage is for those three accounts combined because they all fall under the same account ownership category of single accounts.

A CD may be perfect for you if you have a few "someday soon, but not too soon" financial goals you want to be ready for. You may consider opening a CD if:

• You plan on becoming a parent in the next few years and want to have a nest egg saved up for parental leave, child care and other kid-related expenses.
• You want to start a business ormake a big career changeand need a financial cushion in case things don't go as planned.
• You'vereceived a windfalland want to keep yourself from spending it all down too quickly.
• You're saving up for adown payment on a homeand have some money stashed aside, but you still have a ways to go.
• You'regetting closer to retirementand want to trade the ups and downs of the stock market for something more stable.

You have options when opening a CD. A few different types include:

Short-term CDs

Short-term CDs have terms of less than 18 months. You may not get the highest rate on a short-term CD, but you get the flexibility of being able to access your money sooner.

Long-term CDs

Long-term CDs are for 48+ months. These CDs often offer higher interest rates than shorter-term options.

Liquid or breakable CDs

Liquid or breakable CDs usually don't penalize you for early withdrawal. The trade-off is that liquid CDs typically have a lower interest rate than traditional CDs. They may also have a higher minimum deposit requirement than other CDs.

Callable CDs

Callable CDs give the bank the opportunity to end the CD early. A callable CD may have a higher fixed interest rate than other CD options. But there's the risk that the bank could return your deposit to you before the term ends, so you don't get the full advantage of that higher rate. Often, banks will call a CD if interest rates drop during the term and the bank can borrow money for less. Callable CDs aren't common.

Jumbo CDs

Jumbo CDs are big, both in terms of deposit amount and interest rate. They usually have a higher rate than other options along with a high minimum deposit, such as $100,000. Like callable CDs, jumbo CDs aren't a common option.

IRA CDs

Individual retirement account (IRA) CDslet you save for retirement with a CD. The earnings in the CD are tax-deferred (for a traditional IRA) or after-tax (for a Roth IRA). An IRA CD can provide a predictable source of income as you get closer to retirement.

You don't usually lose money with a CD, which makes it an attractive option if you're looking to stash your cash for a few years. But a CD isn't 100% risk-free.

Say you open a CD with a 12-month term. If you withdraw from the CD before the maturity date, you could lose up to several months of interest. For the sake of this example, let's say you'd losethree months of interest.About two months into having your CD, an emergency comes up and you need to access your CD savings. Since you haven't had the CD for three months, you end up with less money than you put in.

CDs also have opportunity risk. If you lock up your money in a CD and then interest rates rise a month later, you miss out on the higher rate.

Choose your CD account with care. Look at the penalties and understand the term length. Choose a CD with a shorter term so you don't lock up your money for several years.

A CD ladder is a savings strategy that lets you divvy up your savings into several CDs, each of which matures at a different time. The benefit of a CD ladder is that you maintain access to at least some of your savings.

Here's how to set up a CD ladder:

• Divide up your money.The amounts can be the same, or you can put larger deposits in some CDs.
• Choose your CD terms.Pick a mix of terms, such as six months, one year, 18 months and so on.
• Open each CD.You may want to keep a larger balance in the shorter-term CDs so you're not locking up too much money. Pay attention to the deposit minimums, as longer-term CDs may have higher deposit requirements.
• Renew or redeem the CDs when they mature.You may decide to renew your CDs as they mature, keeping your ladder growing, or take the money, depending on your current goals.