A CD is a savings account where you agree to leave your money untouched for a set period in exchange for a higher interest rate
A certificate of deposit (CD) is a contract between you and a bank. You give the bank a lump sum of money—say $1,000 or $5,000—and the bank agrees to pay you a fixed interest rate for a specific length of time, called the term. Common terms are three months, six months, one year, two years, or five years. At the end of the term, you get your original money back plus the interest earned.
The catch is that you cannot withdraw the money before the term ends without paying a penalty. That penalty is usually a loss of some or all of the interest you would have earned, or sometimes a percentage of the principal itself. Because the bank knows your money will stay put, it pays you more interest than a regular savings account would.
CDs are issued by banks and credit unions. The money you deposit is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank, or by the National Credit Union Administration (NCUA) if you use a credit union. That means if the bank fails, your money is protected.
Key Takeaways
- A CD locks your money away for a fixed term in exchange for a may provide interest rate that is higher than a regular savings account.
- You pay a penalty if you withdraw before the term ends, usually in the form of lost interest or a percentage of your deposit.
- The interest rate and term length are set when you open the CD and do not change, even if bank rates rise or fall.
- Your deposit is insured up to $250,000 by the FDIC (or NCUA for credit unions), so your principal is protected even if the bank fails.
How the interest rate works on a CD
When you open a CD, the bank tells you the annual percentage yield (APY) you will earn. This is the total interest you will receive over one year, expressed as a percentage of your deposit. If you open a one-year CD for $5,000 at 4.5% APY, you will earn $225 in interest by the end of the year, and you will have $5,225 to withdraw.
The rate is locked in for the entire term. If you open a two-year CD at 4.5% APY and interest rates rise to 5.5% the next month, your rate stays at 4.5%. That is a risk you take when you open a CD—you are betting that rates will not rise significantly during your term. On the flip side, if rates fall, you are protected by your higher rate.
Interest on a CD is usually compounded, meaning the bank adds the interest to your balance periodically (daily, monthly, or quarterly), and then you earn interest on that interest. The more often interest compounds, the slightly more you earn. Most banks show you the total amount you will have at maturity before you open the CD, so you know exactly what to expect.
Early withdrawal penalties and what they cost
If you need your money before the CD matures, you can withdraw it, but the bank will charge a penalty. The penalty amount varies by bank and by the term length of the CD. A typical penalty on a one-year CD might be three months of interest. On a five-year CD, it might be one year of interest or more.
Some banks publish their penalty amounts upfront; others do not. Before you open a CD, ask the bank what the early withdrawal penalty is. If you withdraw early and the penalty is larger than the interest you have earned so far, you will lose some of your original deposit. For example, if you open a $5,000 CD at 4.5% APY for one year, earn $225 in interest after six months, and then withdraw, a three-month penalty would cost you $112.50—leaving you with $5,112.50 instead of $5,225.
Some banks offer no-penalty CDs, which allow you to withdraw your money early without a penalty, though usually only after a short waiting period (like seven days). These CDs typically pay a lower interest rate than standard CDs, so you are trading yield for flexibility.
CD terms and maturity dates
The term of a CD is how long your money is locked away. Banks offer terms ranging from a few weeks to ten years, though three months to five years are the most common. Shorter terms usually pay lower interest rates; longer terms usually pay higher rates. A three-month CD might pay 4.0% APY, while a five-year CD might pay 4.75% APY.
When your CD reaches its maturity date, the bank will notify you (usually by mail or email) that the term has ended. At that point, you have a window—often seven to ten days—to decide what to do with the money. You can withdraw it, open a new CD with the same bank, or move the money elsewhere. If you do nothing, many banks will automatically renew your CD at the current interest rate for the same term length. Read the renewal terms carefully, because the new rate may be lower than what you earned before.
How CDs compare to regular savings accounts
The main difference between a CD and a regular savings account is flexibility versus yield. A savings account lets you deposit and withdraw money whenever you want, but it pays a much lower interest rate—often 0.01% to 0.5% APY. A CD pays significantly more—currently 4% to 5% APY depending on the term—but you cannot touch the money without a penalty.
If you have money you know you will not need for a year or more, a CD is usually the better choice because the higher rate will grow your money faster. If you might need the money sooner, a savings account is safer because you avoid the penalty risk. Some people use both: they keep an emergency fund in a savings account and put longer-term savings into CDs.
Where to open a CD and what to compare
You can open a CD at any bank or credit union. Large national banks like Chase, Bank of America, and Wells Fargo offer CDs, but they often pay lower rates than smaller banks or online banks. Online banks like Marcus, Ally, and American Express Bank typically pay higher rates because they have lower overhead costs.
When shopping for a CD, compare three things: the APY (the interest rate), the term length, and the early withdrawal penalty. A CD that pays 4.5% for one year is not the same as one that pays 4.0% for one year, even if they are both one-year CDs. Use a CD calculator (most banks provide one on their website) to see how much money you will have at maturity. Also check whether the bank is FDIC-insured and whether your deposit amount is within the $250,000 insurance limit.
CDs as part of a savings strategy
CDs work best when you have a specific savings goal and a timeline. If you are saving for a down payment on a house in three years, a three-year CD locks in a rate and removes the temptation to spend the money. If you are building an emergency fund, a CD is less useful because you need quick access.
Some people use a CD ladder to balance yield and access. You open multiple CDs with different maturity dates—for example, a one-year CD, a two-year CD, and a three-year CD. As each one matures, you can renew it or use the money. This way, you are not locking all your money away for the longest term, and you have cash becoming available at regular intervals.
Frequently Asked Questions
Can I withdraw money from a CD before it matures?
Yes, but you will pay an early withdrawal penalty. The penalty is usually a loss of interest—sometimes three months' worth, sometimes a full year's worth, depending on the bank and the CD term. Some banks offer no-penalty CDs that let you withdraw without a fee after a short waiting period, though they pay lower interest rates.
What happens to my CD when it reaches maturity?
The bank will contact you to let you know the term has ended. You then have a window (usually seven to ten days) to withdraw the money, move it to another account, or open a new CD. If you do nothing, many banks automatically renew the CD at the current rate for the same term length.
Is my money safe in a CD if the bank fails?
Yes. The FDIC insures deposits up to $250,000 per depositor per bank. If the bank fails, the FDIC will return your money. Credit union CDs are insured by the NCUA up to the same limit. Your principal and accrued interest are both protected.
Why would I choose a CD over a savings account?
CDs pay significantly higher interest rates—often 4% to 5% APY compared to 0.5% or less for savings accounts. If you have money you will not need for at least a few months, a CD grows your money faster. The trade-off is that you cannot access the money without paying a penalty.
Do CD rates change after I open one?
No. The interest rate is locked in when you open the CD and stays the same for the entire term, regardless of what happens to market rates. This protects you if rates fall, but it also means you miss out if rates rise during your term.