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How do CDs work?

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Certificates of deposit (CDs) are time deposit financial products that hold your funds for a set period. In exchange, you get fixed interest earnings, making CDs a reliable way to earn a return.

CDs often earn higher interest rates than savings accounts and money market accounts. However, CDs don’t offer as much liquidity. In fact, if you withdraw your money early from a CD, you’ll most likely pay an early withdrawal penalty.

You can purchase these financial products from banks and credit unions, but they differ slightly in name. For example, certificates of deposit are typically called “share certificates” at credit unions. Share certificates are very similar to CDs issued by banks. The only difference is that they are issued by a credit union.

How does a certificate of deposit work?

CDs offer a guaranteed return for keeping your money locked in the account for a set term.

For example, you may find a bank that offers a one-year CD with a 0.55 percent APY. As long as you keep the funds in the CD through the duration of the one-year term, you are guaranteed to earn a 0.55 percent yield on your deposit. However, if you withdraw the funds before the maturity date, you’ll likely have to pay early withdrawal penalties.

Typically, the longer the CD term, the higher the interest rate, although there are exceptions.

When the CD reaches its maturity date, you can redeem it for your initial principal investment plus any interest earned. There’s typically a seven-day or ten-day grace period for you to move the funds out of the CD. After that grace period, the CD term will reset.

There are many types of CDs, though. Be sure to understand each type to find the one that best fits your needs.

CD basics: Important things to consider

Here are some factors to consider when looking for a CD.

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’s term, the higher the APY will be; however, that’s not always the case, and there are other factors that can influence rates. For example, online banks often pay higher yields than brick-and-mortar banks. Financial institutions can also offer promotional CDs with higher-than-usual APYs.

CDs often pay higher rates than standard savings accounts. But again, that’s not always the case and the difference is not always dramatic. For example, currently the best nationally available 1-year CD offers around 0.70 percent APY, while some of the best nationally available savings accounts currently offer around 0.60 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 even issue CDs with unconventional terms, like seven, 13 or 17 months.

Savers could build a CD ladder, which involves buying multiple CDs at once that mature at different times.

CD maturity date

When the term of a CD ends, the CD is said to have matured. When the CD matures, you have the opportunity to make changes to it, such as withdrawing money from the account or renewing it.

For example, if you open a 12-month CD on January 1, 2021, its maturity date will be January 1, 2022. Most banks give you about a week from the maturity date to make changes to your account. If you don’t make any changes, the bank might roll your balance into a new CD with the same term as the previous CD.

The new CD will earn whatever APY the bank is offering for new accounts with that term, so it’s important to keep track of your CD’s maturity date. You don’t want to wind up being stuck with a lower than market rate on a CD.

CD penalties

CDs are a time deposit account, meaning you’re making a commitment to keep your money in the CD for a set period of time. If you want to take money out of your CD before it matures, you’ll usually have to pay a penalty.

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

For example, Bank of America charges:

  • The greater of all interest accrued or seven days’ interest for CDs on the amount withdrawn with a term shorter than 90 days.
  • 90 days’ interest for CDs with terms ranging from 90 days to 12 months on the amount withdrawn.
  • 180 days’ interest for CDs ranging with terms from 12 months to 60 months on the amount withdrawn.
  • 365 days’ interest for CDs with terms greater than 60 months on the amount withdrawn.

CD safety

Like savings accounts, CDs are safe investments. They are insured up to $250,000 per account owner by the Federal Deposit Insurance Corp. (FDIC) at banks and by the National Credit Union Administration (NCUA) at credit unions.

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, generally 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
  • Money to deposit into 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?

Just like when choosing a CD type and term, the amount of money you should park in a CD ultimately depends on your financial situation, goals and timeline.

It can help to connect the maturity of a CD to an event in your life to determine what’s best for you. For example, let’s say you want to purchase a $20,000 car in a year. Putting that money in a 12-month CD would earn you interest and keep you from touching your savings.

There are often minimum deposit requirements, however. Jumbo CDs, for example, often require deposits of $100,000 or more. Some banks, like Ally Bank, have no minimum deposit requirements for their CDs. Others, like Quontic Bank and Marcus by Goldman Sachs, offer CDs that only require $500 to open.

Just be careful not to put all of your money in CDs. Inflation has historically risen over time, which reduces the purchasing power of money earning a yield below the rate of inflation.

What happens when my CD matures?

CDs mature on a specific date. At that point in time, you can collect the principal amount and 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 and how much time you’ll have to collect.

The rules vary by bank or credit union on what happens to your CD if you don’t take action in time. A bank may reinvest your money into another CD with the same term. But some banks will automatically cancel the CD.

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 to collect 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, semi-annual or annual basis.

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Written by
TJ Porter
Contributing writer
TJ Porter is a contributing writer for Bankrate. TJ writes about a range of subjects, from budgeting tips to bank account reviews.
Edited by
Banking editor
Reviewed by
Professor of finance, Creighton University
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Part of  Introduction to Certificates of Deposit