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How do CDs work?

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Certificates of deposit, known as CDs, are bank deposit products that hold your funds for a set period of time. In exchange, the bank pays you a fixed annual percentage yield, or APY, making CDs a safe, reliable way to grow your money.

CDs often earn higher interest rates than savings accounts and money market accounts, but they aren’t as liquid. If you withdraw your money early from a CD, you could pay a stiff penalty fee.

You can open CD accounts at banks and credit unions. Credit unions refer to  CDs as “share certificates,” but they are much like bank CDs.

How a certificate of deposit works

CDs offer a guaranteed return when you keep your money in the account for a set term.

Let’s say you find a bank that offers a one-year CD with a 2 percent APY. As long as you keep the funds in the CD for the duration of the one-year term, you are guaranteed to earn a 2 percent yield on your initial deposit. Typically, the longer the CD term, the higher the interest rate, although there are exceptions.

If you withdraw the funds before the CD term ends, you can expect to pay an early withdrawal penalty, which can eat into your earnings.

When the CD reaches its maturity date, you can redeem it for your initial principal investment, plus the interest it earned. Banks usually offer account holders a seven- to 10-day grace period to move their funds out of a CD.

If you do nothing before the grace period ends, the CD will automatically renew at whatever APY the bank is offering for the product at that time. So the new APY could be higher, lower or the same.

There are many types of CDs, and it pays to become familiar with them if you want to find the one that best fits your goals.

CD basics: Important things to consider

There are several factors to consider when shopping for a CD. Here are the key things to keep in mind.

CD rates

One of the first things to look at when opening a CD is the annual percentage yield. The APY determines how much you’ll earn from the account. Higher APYs mean that you’ll earn more money.

Generally, the longer a CD term, the higher the APY, but that’s not always the case. There are other factors that influence yields, such as Federal Reserve interest rate decisions. The bank you choose can make a big difference, too. Online banks, for example, usually pay higher yields than brick-and-mortar banks. Promotional CD offers also might get you higher APYs.

CDs often pay better rates than standard savings accounts. The best nationally available 1-year CDs are currently offering 2 percent APY and higher, while the best nationally available savings accounts are paying up to 1.75 percent APY.

CD terms

The most common CD terms are three, six, nine, 12, 18, 24, 36, 48 and 60 months. But it’s possible to find shorter and longer terms. Some banks and credit unions issue CDs with unconventional terms, like seven, 13 or 17 months.

Savers can build a CD ladder by buying multiple CDs that mature at different times.

CD maturity date

The end of a CD term is called the maturity date. When the CD matures, you have the opportunity to do one of several things:

  • You can simply let the bank renew the CD at its current APY for that product. The new rate might be different from the rate you got when you first opened the account.
  • You can withdraw your principal, plus interest, and put the money into a new CD, or even a different type of CD, such as a no-penalty CD.
  • You can withdraw your principal and interest and put the money into a different bank account, such as a traditional savings or checking account.
  • You can withdraw your principal and interest and put it into riskier investments such as stocks and bonds.

CD penalties

CDs are a time deposit account, so you’re making a commitment to keep your money in the CD for a set length of time. If you want to take money out of your CD before it matures, you will pay an early withdrawal penalty.

At many banks, the early withdrawal penalty is based on the amount of interest you earn in a day. Typically, CDs with longer terms will charge higher penalties.

As an example, here’s a look at Bank of America’s CD early withdrawal penalties:

  • For CDs with terms shorter than 90 days, all interest earned on the amount withdrawn or seven days’ interest on the amount withdrawn, whichever is greater.
  • For CDs with terms ranging from 90 days to 12 months, an amount equal to 90 days’ interest on the amount withdrawn.
  • For CDs with terms from 12 months to 60 months, an amount equal to 180 days’ interest on the amount withdrawn.
  • For CDs with terms greater than 60 months, an amount equal to 365 days’ interest on the amount withdrawn.

CD types

There are many varieties of CDs, giving savers lots of options for managing their money. Here’s a quick look at some of the most common types of CDs.

Before you buy any product, read the fine print and make sure you understand all the terms and conditions of the account.

  • Traditional CD. A traditional CD requires a one-time deposit that meets the bank’s minimum deposit requirement. It has a fixed term and a fixed APY. Traditional CD rates usually beat those on regular savings accounts.
  • No-penalty (liquid) CD. This product allows you to withdraw funds early without a penalty fee. Banks have different withdrawal parameters. No-penalty CDs generally pay a higher APY than a traditional savings or money market account.
  • Bump-up CD. A bump-up CD allows you to take advantage of a rising rate environment. If your bank raises rates after you bought a CD at a lower rate, you can request the higher rate for the remainder of the CD term.
  • Step-up CD. With a step-up CD, the bank automatically raises your rate by a predetermined amount at certain intervals during the CD term.
  • IRA CD. An IRA CD is held in a tax-advantaged individual retirement account and appeals to risk-averse savers who are willing to sacrifice higher yields for safety and guaranteed returns to build their retirement nest eggs.

CD safety

Like savings accounts, CDs are safe investments. They are federally insured by the Federal Deposit Insurance Corp. at FDIC banks and by the National Credit Union Administration Share Insurance Fund at NCUA credit unions.

Insurance limits are $250,000 per depositor, so as long as your balance doesn’t exceed $250,000, you won’t lose money if the insured bank or credit union closes or is otherwise unable to return your deposit.

How to open a CD

Opening a CD, whether at a bank or credit union, involves choosing a type of CD, picking a term that meets your financial goals and then funding the CD.

Like any financial product, you will need to show the bank or credit union that you are who you say you are in order to open an account. You will generally need to have this information:

  • Your Social Security number (or Individual Taxpayer Identification Number)
  • A valid ID, such as a driver’s license
  • Your date of birth
  • A physical U.S. address
  • A phone number
  • An email address
  • Enough money to meet the bank’s minimum opening deposit for the account

Then, you will fill out the application to open the product at the financial institution.

How much should you invest in a CD?

The amount of money you decide to park in a CD depends on your financial situation, goals and timeline.

Connecting the maturity of a CD to an upcoming event or goal in your life can help you determine what’s best. Let’s say you want to make a down payment on a house in a year. Putting your money in a 12-month CD would earn you interest and keep you from touching your savings.

CDs usually have minimum deposit requirements that vary among banks. Some banks, like Ally Bank and Capital One, have no minimum deposit requirements for CDs. Others, like Quontic Bank and Marcus by Goldman Sachs, require only $500 to open a CD.

Jumbo CDs require much bigger deposits, some as high as $100,000 or more.

Just be careful not to put all of your money in CDs. High inflation reduces the purchasing power of money that is earning a yield below the rate of inflation.

What happens when my CD matures?

CDs mature on a specific date. At maturity, you can collect the principal amount and the interest earned, but the process varies by institution. It’s important to ask your bank or credit union how it provides notice that your CD is maturing.

The rules on what happens to your CD if you don’t take action when it matures vary by bank or credit union. Most institutions give you a window of time called a grace period to act.

If you do nothing before the grace period is up, the bank might automatically renew the CD for the same term but at a different APY. That APY could be lower than the one you had when you first opened the account.

The frequency of interest payments on CDs varies by institution, as well. Keep in mind that while interest might be compounded on a daily, monthly, quarterly or yearly basis, it might be paid out to your account on a different schedule.

Ally Bank, for example, compounds interest on a daily basis. But on CDs of 12 months or less, Ally credits interest to your account at maturity. For CDs more than 12 months, the online bank credits interest to your account annually. Barclays also compounds interest daily, but it credits interest to accounts on a monthly schedule.

Depending on your institution, you may have various options for collecting the interest you earn. You might get the option to take regular interest disbursements or allow interest to accrue in the CD account. If you decide to take a regular disbursement, the way in which interest is paid (often by check or direct deposit) and when it is paid varies by bank, as well.

For example, Barclays allows you to withdraw interest from your account on a monthly basis without penalty and transfer the funds to a Barclays online savings account or a verified external account. However, you can’t withdraw your principal until your CD matures.

At Ally, you can have your accrued interest paid to you by check or transferred to another account on a monthly, quarterly, semiannual or annual basis.

— TJ Porter wrote a previous version of this story.

Written by
Libby Wells
Contributing writer
Libby Wells covers banking and deposit products. She has more than 30 years’ experience as a writer and editor for newspapers, magazines and online publications.
Edited by
Managing editor
Reviewed by
Professor of finance, Creighton University
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Part of  Introduction to Certificates of Deposit