A certificate of deposit is a savings account where you agree to leave money untouched for a set time in exchange for a higher interest rate

A certificate of deposit (CD) is a contract between you and a bank or credit union. You give them a lump sum of money, they promise to hold it for a specific period—anywhere from a few months to five years or longer—and in return they pay you interest at a rate higher than a regular savings account. When the time period ends, you get your original money back plus the interest earned.

The trade-off is simple: you lock your money away for the agreed time. If you need it before the CD matures (the term for when it ends), you pay an early withdrawal penalty. That penalty varies by institution and by how long you agreed to lock the money away. Some banks charge three months of interest; others charge six months or a flat fee. The longer the CD term, the higher the interest rate usually is, but also the larger the penalty if you break it early.

Key Takeaways

  • CDs pay higher interest rates than regular savings accounts because your money stays locked in for a fixed period.
  • Early withdrawal penalties can be steep, so only put money in a CD if you won't need it before the maturity date.
  • CD rates and terms vary by bank and credit union, so comparing offers before you open one saves money.
  • Your CD is insured up to $250,000 by the FDIC (if at a bank) or NCUA (if at a credit union), so your principal is protected even if the institution fails.

How CD interest rates and terms work

Banks set CD rates based on what the Federal Reserve does with interest rates. When the Fed raises rates, banks raise CD rates. When the Fed cuts rates, CD rates fall. This means the rate you see today might not be the rate available next month, and it definitely won't be the rate available next year. Rates change constantly, so if you see a rate you like, locking it in sooner rather than later usually makes sense.

Terms range from three months to ten years, though most banks offer the common ones: three months, six months, one year, two years, three years, and five years. Shorter terms come with lower rates. A six-month CD might pay 4.5%, while a five-year CD from the same bank might pay 5.2%. The bank is paying you more because you're giving up access to your money for longer.

Some banks offer no-penalty CDs, which let you withdraw your money early without a penalty—but the interest rate is lower than a regular CD. You're trading rate for flexibility. Others offer bump-up CDs or step-up CDs, which let you increase your rate once during the term if rates rise, though usually only once and only by a set amount.

What happens when your CD matures

When your CD reaches its maturity date, the bank sends you a notice—usually 10 to 30 days before. At that point, you have choices. You can withdraw the money and the interest you earned. You can let it roll over into a new CD at whatever the current rate is (this happens automatically at many banks if you don't act). Or you can move the money somewhere else entirely.

The automatic rollover is important to watch. If rates have dropped since you opened your CD, rolling over automatically locks you into a lower rate. If rates have risen, you might want to shop around for a better offer at a different bank before the rollover happens. Set a calendar reminder for a week before your maturity date so you have time to decide.

Early withdrawal penalties and when they apply

If you withdraw money from a CD before it matures, you pay a penalty. The penalty is usually expressed as a number of months of interest. A "three-month penalty" means you lose three months' worth of the interest you would have earned. If your CD was paying $500 in annual interest and you withdrew after six months, you'd owe back three months of that—roughly $125—even though you earned it.

Some banks charge a flat dollar amount instead, like $25 or $50. Others charge a percentage of the principal. The penalty structure is in your CD agreement, and you should read it before you open the account. A CD with a steep penalty is risky if there's any chance you'll need the money. If you're not certain you can leave the money untouched, a regular savings account or a money market account might be safer, even if the rate is lower.

Where to open a CD and how to compare rates

You can open a CD at any bank or credit union. Online banks often pay higher rates than brick-and-mortar banks because they have lower overhead costs. Credit unions sometimes pay competitive rates too, especially if you're a member. Shopping around takes 15 minutes and can mean hundreds of dollars in extra interest over the life of the CD.

When you compare, look at three things: the interest rate (expressed as APY, or annual percentage yield), the term length, and the early withdrawal penalty. A CD paying 5.0% APY for one year is not the same deal as one paying 4.8% APY for one year—the difference compounds. A site like Bankrate or DepositAccounts lists current CD rates from multiple banks, updated daily, so you can see what's available without calling around.

Also check whether the bank is FDIC-insured (if it's a bank) or NCUA-insured (if it's a credit union). This means your money is protected up to $250,000 if the institution fails. Most mainstream banks and credit unions carry this insurance, but it's worth confirming before you deposit.

CDs versus other savings options

A CD pays more than a regular savings account but less than you might earn from stocks or bonds over the same time period. It's also less risky than stocks because the rate is may provide and your principal is insured. A money market account sits between a savings account and a CD—it pays more than savings but less than a CD, and you can usually withdraw money without penalty, though there may be limits on how often you can withdraw.

If you have money you won't need for a year or more and you want a may provide return with no risk to your principal, a CD makes sense. If you might need the money sooner, or if you want the possibility of higher returns and can tolerate market risk, other options may fit better. The choice depends on your timeline and your comfort with locking money away.

Frequently Asked Questions

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

No. A CD is a fixed contract. You deposit a lump sum at the start, and that amount stays the same until maturity. If you want to add more money, you'd need to open a separate CD. Some banks let you open multiple CDs at once if you want to stagger them or use different amounts.

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 your bank and your CD term—check your agreement. If the penalty is steep and you're not sure you can leave the money alone, a no-penalty CD or a regular savings account might be a better fit.

Are CDs taxed?

Yes. The interest you earn on a CD is taxable income in the year you earn it, even if you don't withdraw the money until the CD matures. Your bank will send you a 1099-INT form at tax time showing how much interest you earned. Keep that form for your tax return.

What's the difference between a CD and a savings account?

A CD locks your money for a set time and pays a higher rate in exchange. A savings account lets you withdraw anytime without penalty but pays a lower rate. CDs are for money you won't need soon; savings accounts are for money you might need quickly.

Can I open a CD if I have bad credit?

Yes. Banks don't check your credit to open a CD because you're not borrowing money—you're depositing it. They may check your banking history to see if you've had accounts closed for fraud, but a low credit score won't stop you from opening a CD.