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What Is a CD (Certificate of Deposit)?

CDs can have higher rates than standard savings accounts, but your cash isn't as easily accessible.
Banking, CDs
What Is a CD?

Along with higher rates, CDs typically don’t have monthly fees, and there isn’t much risk involved in opening one.

What is a CD?

A CD is different from a traditional savings account in several ways. Savings accounts let you deposit and withdraw funds relatively freely. But with a CD, you agree to leave your money in the bank for a set number of months or years, called the term length, during which time you can’t access the funds without paying a penalty. Term lengths can be as short as a few days or as long as a decade, but the standard range of options is between three months and five years.

With a CD, you agree to leave your money in the bank for a set number of months or years, called the term length, during which time you can’t access the funds without paying a penalty.

The longer the term length — the longer you commit to keeping your money in the account and thus with the bank — the higher the interest rate you’ll earn. Most CDs come with fixed rates, meaning annual percentage yields are locked in for the duration of the term. There are a few exceptions that we will explore below.

CDs at most banks are backed by the Federal Deposit Insurance Corp. for up to $250,000. Share certificates, which is what credit unions call CDs, are insured up to the same amount through the National Credit Union Administration.

Why you might benefit from a CD or share certificate

CDs can pay off for folks who are certain they won’t need that cash during the term length. A five-year CD with a 2.40% APY — about the highest rate you’ll find — will earn over $600 on a $5,000 deposit. Keep the same amount in a savings account that earns a top-of-class rate of 1.30%, and you’d earn about $300 after five years. In this scenario, a CD would earn you about double what you would make with a high-yield savings account.

» If you’re ready to compare CDs, see our list of best CD rates.

When to stick with a savings account

If you end your commitment early by withdrawing the money before the CD matures, you’ll likely be charged a penalty. It varies, but typically you’ll give up several months’ worth of interest accrued.

If there’s a chance you’ll need that cash to cover an emergency, skip the CD and stick to a high-yield savings account.

Take note of any such penalty on a CD before choosing to withdraw early. FDIC and NCUA insurance doesn’t cover penalties incurred by withdrawing money early. If there’s a chance you’ll need that cash to cover an emergency, skip the CD and stick with a high-yield savings account.

Specialty CDs

CDs typically come with a fixed term and a fixed rate of return. But depending on where you bank, you may have access to a few other varieties.

  • Bump-up CD: With these CDs, you can request a higher rate if your bank increases its APYs. These CDs typically have lower interest rates than fixed-rate CDs, and some carry steeper minimum deposit requirements. In most cases, you can request only one rate increase, although long-term CDs may let you do so twice.
  • Step-up CD: This option provides more predictable rate increases, where APYs automatically go up at regular intervals. For example, rates on a 28-month step-up CD might go up every seven months.
  • Low or no penalty for early withdrawal: In exchange for allowing you greater access to your money, these certificates, also called “liquid CDs,” usually provide lower rates of return than traditional CDs and require you to maintain a minimum balance.
  • Jumbo CD: This is essentially the same as a regular CD but with a high minimum balance requirement — upward of $100,000 — as a tradeoff for higher rates.
  • IRA CD: This is a regular certificate that is held in a tax-advantaged individual retirement account.

CD ladders provide flexibility

Some savers might want the higher rates of a three- to five-year certificate but are wary of tying up their money for such a long time. That’s where “laddering” can come in handy. You invest proportionally in a variety of term lengths. Then, as each shorter certificate matures, you reinvest the proceeds in the CD with the longest term.

You invest proportionally in a variety of term lengths. Then, as each shorter certificate matures, you reinvest the proceeds in the CD with the longest term.

Say you have $10,000. With that cash you invest $2,000 apiece in one-, two-, three-, four- and five-year CDs. When the shortest-term certificate matures after one year, you put that money into a new five-year CD. The next year, you reinvest the funds from the matured two-year certificate in another five-year CD. Repeat the process until you have a five-year CD maturing every year. At that point, you’ll have the flexibility of cashing out one certificate a year without facing early withdrawal penalties.

CDs offer low risk, some reward

Investing in a certificate of deposit isn’t the quickest way to grow your money, but it’s not terribly risky, either. A CD with a good rate can play an important role in your overall savings plan.

By choosing the right type of CD, taking advantage of a laddering strategy and avoiding withdrawal penalties, you can earn a solid return on your money, all while having your savings backed by the federal government.

Tony Armstrong is a staff writer at NerdWallet, a personal finance website. Email: tony@nerdwallet.com. Twitter: @tonystrongarm. NerdWallet writer Margarette Burnette contributed to this article.

Updated October 3, 2017.