Certificates of deposit (CDs) are a type of deposit account found at banks and credit unions. With CDs, you set aside money for a designated period of time. In return, you get a fixed rate of return.
CDs can be an excellent savings option. Whether it’s best to choose a long-term or short-term CD depends on your needs. Both options have advantages and drawbacks.
Keep reading to determine the right CD investment for you.
How Do CDs Work?
CDs have fixed interest rates, guaranteeing a certain return based on the balance and term length. You deposit money into a CD and leave it alone until the maturity date. Because the funds are left untouched, increasing a bank’s total available deposits, financial institutions typically pay higher rates on CDs than other deposit accounts. If you withdraw funds early, your bank may charge an early withdrawal penalty.
You can find CD accounts at banks, credit unions and other financial institutions. Like other deposit accounts, CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000, so you can’t lose deposits within this limit.
Most CDs earn compound interest, which is compounded daily, monthly or quarterly depending on the institution and paid out at regular intervals. Banks and credit unions typically offer a grace period once your CD hits maturity during which you can withdraw or add funds, renew your CD, close your account or choose a new term and APY.
What Are CD Rates?
A CD rate, the interest rate you’ll earn on a CD, is typically expressed as an annual percentage yield (APY).
In most cases, CDs feature fixed interest rates that won’t change during your CD term. A fixed rate allows you to earn a predictable return on your CD balance. Some CD types, like bump-up CDs, allow you to increase your interest rate one time during the CD term.
CD Terms
CD terms range from one month to 10 years. (Brokered CDs, purchased through a brokerage firm, may have terms as long as 20 or 30 years.) Most CDs fall into two categories: long-term and short-term CDs. Here’s a closer look at each.
Long-Term CDs
Long-term CDs include two-year CDs, three-year CDs, four-year CDs and five-year CDs. Some banks and credit unions even offer 10-year CDs. Typically, longer-term CDs offer the best CD rates as a trade-off for leaving your funds locked up in an account.
Short-Term CDs
Short-term CDs are the opposite—they require less time commitment and generally come with lower interest rates, although short-term CD rates have been high recently. Short-term CDs generally start at three-month CDs or six-month CDs and go up to one-year CDs. Some institutions offer CDs as short as one month or irregular terms such as seven or nine months.
Discover® 9-Month Certificate of Deposit term
Annual Percentage Yield
4.25%
Minimum Deposit Requirement
$2,500
4.25%
$2,500
Long-Term CD Pros and Cons
Pros
- Typically (but not always) offer higher rates than short-term CDs
- A fixed interest rate protects you against rate drops
- FDIC insured
Cons
- Your money may be inaccessible long-term unless you pay a penalty
Short-Term CDs Pros and Cons
Pros
- Still offer guaranteed returns
- Shorter time commitment than long-term CDs
- FDIC insured
Cons
- Typically (but not always) offer lower rates than long-term CDs
- You can often earn higher APYs with other types of deposit accounts
Find The Best CD Rates Of 2024
How to Choose the Right CD for You
The right CD for you depends on your financial situation, savings goals and the CD rates forecast. The smart play might be to opt for short-term CDs instead of locking yourself into a rate for a longer term. Short-term investments offer more flexibility if the financial climate or your situation changes.
CDs offer guaranteed returns, but the fear of paying early withdrawal penalties may keep you from taking advantage. To avoid these costly fees, consider building a CD ladder. You do this by opening several CD accounts with varying maturity dates. As each CD hits that date, you can choose to withdraw your money or roll it over into a new CD.
If you’re not sure you can tie up your funds longer term without touching them, other deposit accounts could offer similar or better rates than CDs right now. Both high-yield savings accounts and money market accounts may offer higher APYs and more flexibility than CDs.
When To Choose Long-Term CDs
Consider a long-term CD if you expect rates to decrease in the future and you can afford to lock your funds up for at least a couple of years. That way, you can lock in a higher guaranteed rate now and continue earning it even after rates fall. Generally, banks save their highest rates for longer CD terms, although some offer special rates on shorter CD terms.
When To Choose Short-Term CDs
Consider a short-term CD if you want to maximize your savings through a high APY while freeing up cash more regularly. With shorter CD terms, you can access or withdraw your money sooner, making them ideal if you think your financial situation could change while you’re building up your savings. These CDs are also worth considering if you expect rates to go up because you can reinvest your money at a higher rate when they mature.
Frequently Asked Questions (FAQs)
What is a long-term CD?
A long-term CD is generally a CD term between two and five years. Traditionally, long-term CDs have typically offered higher rates than shorter CD terms in exchange for tying up your money for a longer term. Some institutions provide CD terms of up to 10 years or more, although this isn’t as common.
What is a short-term CD?
A short-term CD is generally a CD term that’s one year or less. Most financial institutions offer CD terms as short as three months, but some offer even shorter one-month CDs.
Are CDs worth it?
CDs are a viable short-term investment option, offering guaranteed returns. Whether opening a CD is right for you depends on your current financial situation, the reason you are saving and whether you can afford to let the money sit in an account untouched for a specific period.
Can you lose your money with a CD?
CDs are considered a low-risk investment. They offer guaranteed returns over the length of the CD term. If you choose to pull funds from your CD before it reaches maturity, you’ll have to pay an early withdrawal penalty, assuming it’s not a type of CD called a no-penalty CD.
The penalty amount typically depends on how long the CD has matured and is usually a portion of the interest earned with the CD. With some shorter-term CDs, the early withdrawal penalty can erase most, if not all, of the interest earned, and occasionally some of the principal investment, so it pays to compare account offerings very carefully.
Are CDs FDIC insured?
Yes, CD accounts at banks are FDIC insured for up to $250,000 per depositor, for each account ownership category, in the event of a bank failure. All federal credit unions and most state-chartered credit unions provide similar protection via the National Credit Union Administration (NCUA).
Do CDs pay interest monthly?
Each bank or credit union determines the CD interest payment schedule. Generally, interest earned on CD accounts compounds daily or monthly and is credited monthly.
