A certificate of deposit is money you agree to leave in a bank account for a set time in exchange for a higher interest rate

A certificate of deposit, or CD, is a straightforward agreement between you and a bank. You give the bank a sum of money — anywhere from $500 to $100,000 or more, depending on the bank — and promise not to touch it for a specific period. In return, the bank pays you interest at a rate higher than a regular savings account. When the time period ends, you get your original money back plus the interest you earned.

The catch is that if you withdraw your money before the agreed time is up, the bank charges you a penalty. That penalty usually means you lose some or all of the interest you earned, and sometimes you lose a small amount of your original deposit too. This is why CDs work best for money you know you will not need for a while.

CDs are one of the safest places to put money at a bank because they are insured by the Federal Deposit Insurance Corporation (FDIC). This means if the bank fails, the government guarantees you will get back up to $250,000 per account holder per bank. You cannot lose your principal — the money you put in — as long as you stay within that limit.

Key Takeaways

  • A CD locks your money away for a set time — typically three months to five years — in exchange for a higher interest rate than a savings account.
  • You earn interest on your deposit, and that interest is paid to you when the CD reaches its maturity date, the day the time period ends.
  • Withdrawing money early triggers a penalty that usually costs you some or all of the interest you would have earned.
  • Your deposit is protected by FDIC insurance up to $250,000, so your principal is safe even if the bank fails.
  • CDs work best for money you will not need for several months or years and want to grow with minimal risk.

How the time period and interest rate work together

When you open a CD, you choose the term — the length of time your money stays locked in. Common terms are three months, six months, one year, two years, three years, and five years. Some banks offer terms as short as one month or as long as ten years, but these are less common.

The longer the term, the higher the interest rate the bank usually offers. A one-year CD might pay 4.5 percent annual interest, while a five-year CD at the same bank might pay 5.2 percent. The bank pays you more because it gets to use your money for longer. The interest rate is locked in when you open the CD, so it does not change even if the bank's rates go up or down later.

Interest on a CD is typically paid in one of two ways. Some banks add the interest to your account at maturity — the day your term ends — so you receive a lump sum of your original deposit plus all the interest at once. Other banks pay interest monthly or quarterly, adding it to your CD balance so it earns interest too, a process called compounding.

What happens when your CD reaches maturity

When your term ends, your CD reaches maturity. At that point, the bank sends you a notice — usually by mail or email — telling you what happens next. You have a window of time, usually five to ten days, to decide what to do with your money.

You have three choices. First, you can withdraw the full amount — your original deposit plus all the interest you earned — and move the money to another account or bank. Second, you can let the bank automatically renew your CD into a new term at whatever the current interest rate is. Third, you can withdraw part of the money and renew the rest into a new CD. If you do nothing and your bank's policy allows automatic renewal, the CD will roll over into a new term at the bank's current rate.

This is an important moment to pay attention to. If interest rates have risen since you opened your CD, you might want to shop around at other banks before renewing. If rates have fallen, your current rate might look better than what is available elsewhere. Banks count on people ignoring their maturity notices and automatically renewing, so reading that notice and making an active choice usually works in your favor.

The early withdrawal penalty and when it matters

If you need your money before the CD matures, you can withdraw it, but the bank will charge you a penalty. The penalty amount varies by bank and by the term of your CD. A typical penalty for a one-year CD might be three months of interest. A five-year CD might carry a penalty of one year of interest. Some banks charge a flat dollar amount instead — say, $25 or $50 — regardless of how much interest you earned.

Here is what that means in practice. Suppose you open a one-year CD with $10,000 at 4.5 percent interest. You would earn about $450 in interest over the year. If you withdraw the money after six months, the bank might charge you a penalty equal to three months of interest, or about $112.50. You would receive $10,000 plus $225 in interest (the six months you did earn) minus the $112.50 penalty, for a total of $10,112.50. You still come out ahead, but you earn less than if you had waited.

The penalty can sometimes be large enough that you lose money. If you withdraw very early from a long-term CD, the penalty might exceed the interest you earned, meaning you get back less than your original $10,000. This is why CDs are not right for money you might need soon. They work best for money you are confident you will not touch.

CDs versus savings accounts and money market accounts

A regular savings account has no time lock. You can withdraw money whenever you want without penalty. In exchange, the interest rate is lower — often less than 1 percent. A CD locks your money away but pays more interest because the bank knows it can count on having your money for a set period.

A money market account sits between the two. It pays more interest than a savings account but less than a CD, and it lets you write checks or make withdrawals, though usually with a limit on how many you can make per month. If you want the highest rate and do not need the money, a CD wins. If you want flexibility, a savings account wins. A money market account is a compromise.

All three are FDIC insured at most banks, so your money is equally safe in any of them. The choice comes down to how long you can lock the money away and what interest rate you need.

Where to open a CD and what to compare

You can open a CD at any bank or credit union. Online banks often offer higher interest rates than brick-and-mortar banks because they have lower overhead costs. Credit unions sometimes offer competitive rates to their members. Before you open a CD, compare the interest rate, the term options, and the early withdrawal penalty across at least three institutions.

The interest rate is the most obvious thing to compare, but the penalty matters just as much. A bank offering 5.0 percent with a one-year penalty is better than one offering 5.2 percent with a three-year penalty if you think there is any chance you might need the money early. Read the fine print on the penalty before you commit.

Also check whether the bank compounds interest monthly, quarterly, or at maturity. Monthly compounding means your interest earns interest too, which adds up over time. For a five-year CD, this can make a meaningful difference in what you receive at the end.

CDs as part of a savings plan

Many people use CDs as a way to set money aside and make it harder to spend. Because there is a penalty for early withdrawal, a CD creates a barrier between you and your money. This can be useful if you are saving for a specific goal — a down payment on a home, a car, a vacation — and want to protect that money from the temptation to spend it on something else.

Some people build a CD ladder by opening multiple CDs with different maturity dates. For example, you might open five one-year CDs, staggering the maturity dates so one matures every few months. As each one matures, you can renew it for another five years, or withdraw the money if you need it. This approach gives you some of the higher interest rate of a long-term CD while keeping some of your money accessible more frequently.

Frequently Asked Questions

Can I withdraw money from a CD before it matures?

Yes, but you will pay an early withdrawal penalty. The penalty usually costs you some or all of the interest you earned, and in some cases a small amount of your principal. The exact penalty depends on your bank and how long your term is. Check your CD agreement to see what the penalty is before you open the account.

What is the difference between a CD and a savings account?

A savings account has no time lock and lets you withdraw money anytime without penalty, but it pays a much lower interest rate. A CD locks your money for a set period and pays higher interest, but charges a penalty if you withdraw early. Both are FDIC insured.

How much interest will I earn on a CD?

Interest depends on the bank, the term you choose, and the current interest rate environment. Longer terms usually pay higher rates. To find out what you will earn, multiply your deposit by the annual interest rate and the number of years. For example, $10,000 at 4.5 percent for one year earns $450.

What happens if the bank fails?

Your CD is protected by FDIC insurance up to $250,000. If the bank fails, the government guarantees you will receive your full deposit plus all interest earned, up to that limit. You do not lose money because of bank failure.

Can I move a CD to a different bank?

You can withdraw your money when the CD matures and move it to another bank without penalty. If you want to move it before maturity, you will pay the early withdrawal penalty. Some banks offer CD transfers, but this is rare and usually only available between affiliated institutions.