CDs, or certificates of deposit
, are bank accounts that pay interest in exchange for keeping a lump sum of money in the account for a pre-determined amount of time. The interest rate
will typically depend on the amount of money deposited, and the term length of the CD.
Here are some frequently asked questions about CDs and what sets them apart from other types of bank accounts:
How Do CDs Differ from Checking and Savings Accounts?
are primarily used as funds for expenses. Money is usually deposited and removed regularly, and while it is best to maintain a balance in a checking account, it is not often used as a tool for savings. Some checking accounts do pay interest
when the account balance reaches a certain threshold, but most do not.
CDs are more similar to savings accounts
because they are often used to save money
and grow it for future use. Unlike a savings account however, you will not be able to move money out of a CD until its term is over. This is also known as the “maturity date”. Taking money out of a CD before it matures will usually result in you being charged an early withdrawal penalty
The upside is that CDs typically pay out a higher interest rate
than savings accounts, allowing you to make more money over time. With a CD you “lock in” your rate for the entire term. This is different than a savings account, where your interest rate may fluctuate
anytime your bank changes the rate of the product. If you open a 3-year CD at 0.75% APY, you will receive that rate until the CD matures 3 years later, even if the bank reduces the rate of the product to 0.50% APY six months after you open the account.
It’s also worth keeping in mind that while you can add money to a savings account at any time, most CDs will only permit you to deposit funds at account opening, and when rolling the CD over to a new term at maturity. However, some banks do offer add-on CDs
that allow you to add funds to the account at any time during the term length. Keep these distinct products in mind before choosing which type of CD account to open.
Another difference between CDs and savings accounts is monthly fees. Some savings accounts come with maintenance fees. These can be recurring monthly fees, or they may be tied to your account balance or the number of transactions you make in a month. With CDs, you typically will not have to worry about maintenance fees.
Why Would a CD Be Useful?
CDs can be significant savings tools for those looking to put money away for a large purchase or who want to grow their money over time
. A CD is ideal for people who can afford to put aside a certain amount of money knowing they will not need it. As mentioned before, CDs typically provide a higher return than a traditional savings account. A CD is also a low-risk investment
. Unlike stocks or cryptocurrencies, you don’t risk losing your money with CDs. They provide a guaranteed rate of return, and as long as you open a CD at an FDIC-insured bank, your deposit will be protected in the event of a bank failure. FDIC insurance typically covers up to $250,000 per depositor, per financial institution, but some banks offer protection on funds that exceed FDIC limits. At BankFive for example, all deposits – including CDs – are protected by the Depositors Insurance Fund
, which covers all deposits above FDIC limits.
Would a CD Replace Your Checking and Savings Account?
Since your money is not readily accessible
when placed in a CD, this type of financial product should be used in addition to a checking and savings account, not instead of them. You’ll still need a checking account to pay your monthly bills, withdraw money, and make purchases with your debit card
. You’ll also want money in a savings account that you can easily access to cover emergencies
, unplanned expenses, or big-ticket costs like vacations
, or home renovations
. A CD should be one of multiple savings vessels in your financial portfolio.
Why Do CDs Have Different Lengths and What Do They Mean for Your Savings?
CDs come in a wide range of terms
. You can choose from short-term CDs with terms less than one year, or longer-term CDs, which could range from one to five years, or more. The term of the CD is the length of time you will need to keep your money in it. After the term is over, the CD matures, and you can then either withdraw your funds – including any interest earned – or you can roll over your CD to a new term. The CD length you choose
will depend on how quickly you will need access to your money and what rate of return you are looking to achieve.
- Short-Term. Short-term CDs typically have terms less than one year. They are the most flexible option as they allow access to your money sooner. There is also usually a lower penalty fee for withdrawing funds early from short-term CD than a longer-term CD. Some short-term CDs even offer no penalties for withdrawing funds early. The main drawback with short-term CDs and no-penalty CDs is that they usually have significantly lower interest rates than mid-range and long-term CDs. Therefore, they are usually only a good choice for those who are okay with a lower rate of return because they do not want their money tied up too long.
- Mid-range. Mid-range CDs typically have terms of one to three years. Three-year CDs will usually offer higher interest rates than two-year CDs, and two-year CDs will typically have a higher rate than one-year CDs. All will usually have a higher rate of return than short-term CDs. Mid-range terms can be a good option for those who can afford to set aside some money for a few years. Mid-range CDs often have promotional rates associated with them as well, which can potentially rival long-term rates. It’s important to keep in mind though that with most mid-range CDs, the penalty for withdrawing funds early will be at least several months of interest. Because of the heftier penalty fees associated with mid-range CDs, it is recommended to have a separate emergency fund, so you don't have to cash out your CD when times get tough.
How is a CD Different from a Money Market Account?
- Long-term. Long-term CDs, which often fall into the range of four to five years, will usually provide you with the highest CD rates available. Before opening a long-term CD though, it’s important to remember that your rate will be locked in for the entire term. While this can be ideal when CD rates are in a decline phase, it can be frustrating when rates are on the rise. No one wants to lock in a 5-year CD at 0.65% APY only to have the product rate increase to 2.00% APY the following year. Some banks do offer “bump-up” CD options to help alleviate this fear. A bump-up CD allows you to request to be “bumped-up” to a higher interest rate if the product rate increases while you have the account. Like mid-range CDs, it is essential to have additional backup funds accessible with a long-term CD to you so you don’t have to withdraw money from the account before the term is over, as doing so will leave you facing potentially steep penalty fees.
Although you may find more flexibility with a money market account
– as they typically allow you to deposit and withdraw funds at will – CDs usually offer higher interest rates. With a higher rate of return and a set amount of funds in a CD, you can have a good idea of how much interest you will earn over time. With a CD though, you must be confident you will not need the funds for the set term length, as you could be subject to early withdrawal penalties for taking money out of the account early. With a money market
account however, there is typically no penalty for a large withdrawal.
CDs are a great way to reach your savings goals, particularly if you’re saving for a specific goal like a large project, purchase, or event. The key to choosing the correct CD is understanding all possible penalties and having a good feel for how long you can afford to have your money tied up. For help deciding on the best CD option for you, review our current CD rates, or visit one of our 13 full-service branches.