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

A certificate of deposit (CD) is a savings product where you give a bank or credit union a lump sum of money, agree not to touch it for a specific period, and receive a fixed interest rate in return. The bank pays you that rate regardless of what happens to market interest rates during your CD term. When the term ends—called the maturity date—you get your original money back plus all the interest you earned.

The trade-off is simple: you lose access to your cash for months or years, and the bank gets to use your money during that time. In exchange, you get a rate that is almost always higher than what a regular savings account offers. The longer you lock your money away, the higher the rate typically is.

Key Takeaways

  • You deposit a fixed amount, choose a term length (three months to five years or longer), and receive a may provide interest rate for that entire period.
  • Interest compounds at intervals set by the bank—usually monthly or quarterly—and is added to your balance automatically.
  • If you withdraw money before the maturity date, you pay an early withdrawal penalty that reduces your earnings or principal.
  • On the maturity date, your CD automatically renews into a new CD at the current rate, or your money moves to a regular savings account, depending on your bank's policy.
  • CDs are FDIC-insured up to $250,000 per depositor per bank, so your principal is protected even if the bank fails.

How you open a CD and what happens to your money

You start by choosing the amount you want to deposit—this can be as little as $500 at some banks or $1,000 at others, though minimums vary. You also choose the term: three months, six months, one year, two years, five years, or sometimes longer. The bank then locks in an interest rate for that exact term and gives you a CD agreement that states the rate, the maturity date, and the early withdrawal penalty.

Your money sits in the CD account and earns interest on a schedule the bank sets. Most banks compound interest monthly or quarterly, meaning they calculate the interest owed and add it to your balance. That new balance then earns interest in the next period—you earn interest on your interest. The rate never changes, even if the bank raises or lowers rates for new CDs.

What the early withdrawal penalty actually costs you

If you need the money before the maturity date, you can withdraw it, but you will pay a penalty. The penalty is usually stated as a number of months of interest—for example, "three months of interest" or "six months of interest." If your CD earns $200 in interest over the year and the penalty is three months of interest, you lose $50 from your earnings.

On a longer-term CD or a very early withdrawal, the penalty can be large enough to eat into your principal. A two-year CD with a six-month interest penalty might cost you money if you withdraw after four months. Always read the penalty terms before you open the CD, because they vary widely between banks and between different CD products at the same bank.

How interest compounds and what you actually earn

The interest rate on a CD is stated as an annual percentage yield, or APY. This is the actual return you will earn in one year if you hold the CD for the full term and do not withdraw early. If a CD offers 4.5% APY and you deposit $10,000 for one year, you will earn approximately $450 (the exact amount depends on how the bank compounds interest).

For CDs longer than one year, the compounding matters more. A two-year CD at 4.5% APY does not simply earn 9% total. Instead, the interest earned in year one gets added to your balance, and year two's interest is calculated on that larger amount. This is why longer terms at higher rates can feel like they grow noticeably faster.

What happens when your CD reaches maturity

On the maturity date, your CD stops earning interest at the old rate. Your bank will then do one of two things, depending on its policy and what you instructed them to do. Some banks automatically renew your CD into a new CD at the current rate for the same term length. Others move your money into a regular savings account where it earns a much lower rate.

You should check your CD agreement or contact your bank before maturity to understand what will happen. If you do not want automatic renewal, you can usually request that your money be moved to a savings account or transferred out entirely. If the bank renews your CD and you do not want it renewed, you typically have a grace period—often 7 to 10 days—to withdraw the money without penalty.

How CD rates compare to other savings products

CDs almost always pay more than a regular savings account at the same bank because you are giving up access to your money. A savings account might pay 0.01% APY while a one-year CD at the same bank pays 4.0% or higher. The difference grows with longer terms—a five-year CD might pay 4.5% while a savings account stays at 0.01%.

Money market accounts sometimes offer rates close to CDs but with more flexibility to withdraw. High-yield savings accounts at online banks can match or beat CD rates while keeping your money accessible. The choice depends on whether you need the money soon and whether the higher CD rate is worth locking your cash away.

FDIC insurance and what happens if the bank fails

CDs held at FDIC-insured banks are protected up to $250,000 per depositor per bank. This means if the bank fails, the federal government guarantees you will get your money back, including all interest earned up to the maturity date. If you have multiple CDs at the same bank, the $250,000 limit applies to your total across all of them.

If you want to protect more than $250,000 in CDs, you can open CDs at different banks—each bank's $250,000 limit is separate. Credit unions offer similar protection through the National Credit Union Administration (NCUA) up to $250,000 per member per institution. This insurance does not cover losses from early withdrawal penalties, only the principal and earned interest.

Frequently Asked Questions

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

No. A CD is a fixed deposit—you choose the amount when you open it, and that amount stays the same until maturity. If you want to save more, you open a separate CD or use a savings account. Some banks offer "add-on CDs" that allow deposits during a window after opening, but these are less common.

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

A savings account lets you deposit and withdraw money anytime with no penalty, but it pays a much lower interest rate. A CD locks your money for a set term and pays a higher rate, but you lose access and face a penalty if you withdraw early. Choose a savings account if you need flexibility; choose a CD if you have money you will not need for months or years.

Do I have to pay taxes on CD interest?

Yes. CD interest is taxable income in the year it is earned, even if you do not withdraw it. Your bank will send you a 1099-INT form at tax time showing how much interest you earned. You report this on your tax return. This is one reason CDs in regular taxable accounts make more sense for shorter terms—the tax bill can eat into your gains on very short CDs.

What happens if interest rates drop after I open my CD?

Your rate stays the same for the entire term. This is the main benefit of a CD—you are protected from rate drops. If rates fall, you keep earning the higher rate you locked in. If rates rise, you are stuck with the lower rate, which is the downside of a CD.

Can I use a CD as collateral for a loan?

Yes. Some banks will lend you money using your CD as collateral, and you keep earning interest on the CD while you repay the loan. This lets you access cash without triggering the early withdrawal penalty. Ask your bank whether they offer CD-secured loans and what the interest rate would be.