Savings 101: What is a CD (Certificate of Deposit)?

With so many banking products available, choosing which type of account to open can be just as stressful as deciding where to bank. For consumers looking to earn interest on their deposits, the highest interest rate is definitely important, but make sure to consider the features and drawbacks that are associated with each type of account. Some may fit your needs more closely than others.

Table of Contents

  1. The basics
  2. Types of CDs
  3. CD ladders
  4. Fees and penalties
  5. CD rates

The basics

Certificates of Deposit (CDs) are common savings products offered by many banks and credit unions. The key difference between a regular savings account and a CD is that early withdrawal from a CD in advance of pre-specified term leads to penalty fees (which is why they are sometimes called “time deposits”).

CDs are typically offered in terms of 3 months, 6 months, 1 year, 2 years, 3 years, 5 years or greater, although some exceptions do exist.  In exchange for locking away a consumer’s cash, CDs usually offer higher yields than a regular savings account. The rates typically increase with the length of deposit terms.

Deposits in a bank CD are federally insured by the FDIC for up to $250,000 per depositor, per insured bank. For members of a federally insured credit union, CDs are insured up to the same amount through the NCUA.

Types of CDs

Most commonly, CDs are offered with a fixed interest rate and term. However, some institutions will implement variations on these products, usually as promotional accounts, to attract new depositors. Here are some common types

  • Variable-rate CD – these are sometimes linked to some market index or may allow the depositor to take advantage of future rate increases
  • Low/no-penalty for early withdrawal – some other drawback usually applies such as a lower initial rate that may increase with time.
  • Callable CD – allows the bank or credit union to shorten the CD term
  • Jumbo CD – essentially the same as a regular CD, but with a very high minimum balance (typically $100,000) as a tradeoff for higher rates
  • IRA CD – these are regular CDs that are held within a tax-advantaged individual retirement account (IRA)

CD ladders

Many consumers may wish to take advantage of the higher rates of a 3-5 year CD, but are wary of tying up their money for such long periods of time. CD ladders help to alleviate this issue. The process is fairly simple – invest proportionally in a variety of CD term lengths, then as each shorter CD matures, reinvest the proceedings in the longest term. For example, take a consumer with $10,000 of savings

  1. Invest $2,000 in each of a 1-year, 2-year, 3-year, 4-year and 5-year CD
  2. In 1 year, when the first CD matures, withdraw the $2,000 + earned interest and re-deposit the amount in a 5-year CD
  3. The following year, take the proceedings from the 2-year CD and re-deposit in another 5-year CD
  4. Repeat the process until a 5-year CD is maturing each year 

Fees and penalties

Most CDs will incur a fee or penalty for early withdrawal (before the predetermined maturity date). The penalty is typically a proportion of the interest earnings (e.g. 60 days of interest) depending on the original CD term and may be subject to a minimum fee.
Consumers should take note of the potential fee for their particular account before choosing to withdraw early. The loss of interest may outweigh the benefits of accessing the money immediately.

CD rates

CD yields are typically quoted the annual percentage yield (apy), which takes into account the compounding period (the frequency with which a bank chooses to apply interest to an account). Banks can choose to compound rates on a yearly, quarterly, monthly or even daily basis.

Each week, NerdWallet analyzes the CDs at thousands of banks and credit unions. View the report for the most recent week to find the financial institutions with the best CD rates, as well as average rates by length of term and state.

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