A CD locks your money away for a set time in exchange for a higher interest rate than a savings account

A certificate of deposit (CD) is a contract between you and a bank. You give the bank a lump sum of money, agree not to touch it for a specific period (called the term), and the bank pays you a fixed interest rate on that money. When the term ends, you get your original deposit back plus all the interest earned.

The bank uses your money during that time — lending it out, investing it — which is why they pay you more interest than they would on a regular savings account. The tradeoff is yours: higher interest in exchange for locking the money away. If you withdraw before the term ends, you pay a early withdrawal penalty, which is usually a certain number of months' worth of interest.

CDs are FDIC insured up to $250,000 per depositor per bank, meaning your money is protected even if the bank fails. This makes them one of the safest places to put money that you know you won't need for a while.

Key Takeaways

  • You deposit a fixed amount, choose a term length (typically three months to five years), and receive a may provide interest rate for that entire period.
  • Your money earns interest automatically and is added to your account when the CD matures, or you can choose to receive it separately.
  • Withdrawing money before the term ends triggers an early withdrawal penalty, usually equal to a few months of interest.
  • When your CD matures, you can withdraw the money, move it to a new CD, or let it roll over into a new CD at the bank's current rate.
  • CD rates vary by bank, term length, and deposit amount, so comparing offers across banks can mean hundreds of dollars in extra interest.

How the interest rate and term length work together

When you open a CD, you choose two things: how much money to deposit and how long to lock it away. The bank then tells you the interest rate you'll earn for that specific term. Longer terms almost always come with higher rates — a five-year CD will pay more than a one-year CD at the same bank, because the bank gets to use your money for longer.

The interest rate is fixed, meaning it does not change even if the bank raises or lowers rates for new customers. If you lock in 4.5% for two years, you earn 4.5% for the full two years, regardless of what happens in the market. This certainty is valuable when rates are falling, but it works against you if rates rise sharply after you buy the CD.

Interest compounds, usually daily or monthly depending on the bank. That means you earn interest on your interest. A $10,000 CD at 4% annual interest compounded daily will earn slightly more than $400 over one year because the daily interest gets added to your balance and earns interest itself.

What happens when your CD reaches maturity

The maturity date is the day your term ends. On that date, your CD stops earning interest and you have options. Most banks give you a window of 7 to 10 days after maturity to decide what to do — this is called the grace period.

During the grace period, you can withdraw all your money (the original deposit plus all interest earned) without penalty. You can also open a new CD at the bank's current rates, or move the money to a savings account. If you do nothing, many banks will automatically roll over your CD into a new one at the current rate for the same term length — but read your CD agreement, because some banks do this and some do not.

The rollover rate is whatever the bank is currently offering for that term, not the rate you had before. If rates have dropped, your new CD will pay less. If rates have risen, you'll earn more. This is why it pays to check your maturity date and shop around before the grace period ends.

Early withdrawal penalties and when they apply

If you need your money before the maturity date, you can withdraw it, but you'll pay a penalty. The penalty amount varies by bank and by term length. A common structure is a penalty equal to three months of interest on a one-year CD, or six months of interest on a five-year CD. Some banks use a flat dollar amount instead.

The penalty comes out of your interest earnings first. If you've earned $200 in interest and the penalty is $150, you get back your original deposit plus $50. If the penalty exceeds your interest earned, it comes out of your principal — you get back less than you deposited.

A few banks offer no-penalty CDs that let you withdraw early without a penalty, but they pay lower interest rates to compensate. These make sense if you think you might need the money but want more than a savings account offers.

How CD rates differ across banks and terms

Banks set their own CD rates based on what they think they can earn with your money and how much competition they face. Online banks typically offer higher rates than brick-and-mortar banks because they have lower overhead costs. Credit unions sometimes offer competitive rates to members. The same bank will offer different rates for different term lengths.

A bank might offer 4.0% for a one-year CD, 4.3% for a two-year CD, and 4.6% for a five-year CD. Another bank down the street might offer 3.8%, 4.1%, and 4.4% for the same terms. Over a five-year period, that 0.2% difference on a $10,000 CD adds up to roughly $100 in extra interest — which is why shopping around matters.

Some banks also offer higher rates for larger deposits. You might earn 4.5% on a $10,000 CD but 4.7% on a $25,000 CD. These jumbo CD rates are worth checking if you have a larger sum to deposit.

The difference between CDs and savings accounts

A savings account has no term and no penalty for withdrawal — you can take money out whenever you want. A CD locks your money for a set period in exchange for a higher rate. Savings accounts are more flexible; CDs pay more interest. The choice depends on whether you need the money soon.

If you have an emergency fund or money you might need within the next year, a high-yield savings account makes more sense. If you have money you won't touch for three years or longer, a CD will earn you significantly more. Some people split the difference: keep three to six months of expenses in a savings account and put longer-term money into CDs.

How to compare CDs across different banks

Start by listing the term length you want — one year, three years, five years, whatever matches when you'll need the money. Then visit the websites of several banks (online banks, your current bank, local credit unions) and note the rate each offers for that term and your deposit amount.

Multiply the rate by your deposit to estimate total interest earned. A $5,000 CD at 4.5% for one year earns roughly $225 in interest (the actual amount will be slightly higher due to compounding). A $5,000 CD at 4.2% earns roughly $210. The difference is small on small deposits but grows with larger sums.

Also check the early withdrawal penalty before you open the CD. A bank with a slightly higher rate but a steep penalty might not be worth it if there's any chance you'll need the money early. Read the fine print about what happens at maturity — does it roll over automatically, and at what rate?

Frequently Asked Questions

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

No. A CD is a fixed contract for a fixed amount. Once you open it, you cannot add more money. If you want to deposit additional funds, you must open a separate CD. Some banks let you open multiple CDs at once if you want to spread money across different terms.

What if I need my money before the CD matures?

You can withdraw it, but you'll pay an early withdrawal penalty. The penalty amount depends on the bank and the term length — check your CD agreement to see what it is. Some banks offer no-penalty CDs that let you withdraw without a fee, though they pay lower interest rates.

Are CDs taxed?

Yes. The interest you earn on a CD is taxable income in the year you earn it. The bank will send you a 1099-INT form at tax time showing how much interest you earned. If the CD is in a retirement account like an IRA, the interest is not taxed until you withdraw from the account.

What happens if the bank fails?

Your CD is protected by FDIC insurance up to $250,000. If the bank fails, the FDIC pays you your full deposit plus all interest earned, even if the bank cannot. This protection applies per depositor per bank, so if you have multiple CDs at the same bank, they count toward the $250,000 limit combined.

Should I buy a CD if interest rates are rising?

If you think rates will keep rising, a shorter-term CD (one or two years) lets you reinvest at higher rates sooner. A longer-term CD locks you in at today's rate, which could be a disadvantage if rates climb. But if you want certainty and do not want to monitor rates, a longer CD removes that worry.