A CD is a savings account where you lock your money away for a set time in exchange for a higher interest rate

A certificate of deposit (CD) is a contract between you and a bank. You give the bank a lump sum of money—say $5,000—and agree not to touch it for a specific period, called the term. In return, the bank pays you a fixed interest rate, which is almost always higher than what you'd earn in a regular savings account. When the term ends, you get your original money back plus the interest you've earned.

The bank uses your money during that locked period. They lend it out, invest it, or use it to fund their operations. That's why they're willing to pay you more interest than they would for money you could withdraw anytime. You're essentially trading access to your cash for a better return.

CDs come in different term lengths—typically 3 months, 6 months, 1 year, 2 years, 5 years, or 10 years. The longer the term, the higher the interest rate usually is. A 5-year CD will pay more than a 1-year CD at the same bank, because the bank has your money for longer and can count on it.

Key Takeaways

  • You deposit a fixed amount of money and agree not to withdraw it until the term ends, usually ranging from three months to ten years.
  • The interest rate on a CD is locked in when you open the account and does not change, even if the bank's rates go up or down.
  • If you withdraw money before the term ends, you pay an early withdrawal penalty, which is typically three to six months of interest.
  • When the term ends, your CD matures and you can withdraw your money, renew it for another term, or move it elsewhere.
  • CDs are insured by the FDIC up to $250,000 per depositor per bank, so your principal is protected even if the bank fails.

How the interest rate works and why it's locked in

When you open a CD, the bank tells you the annual percentage yield (APY)—the exact rate you'll earn for the entire term. That rate does not change. If you open a 2-year CD at 4.5% APY, you'll earn 4.5% every year for those two years, even if the bank raises its rates to 5.5% next month.

This works both ways. If rates fall, you're protected—you keep earning 4.5%. But if rates rise, you're locked in at the lower rate. That's the trade-off for knowing exactly what you'll earn before you commit your money.

The interest compounds, usually daily or monthly depending on the bank. Compounding means you earn interest on your interest. A $10,000 CD at 4% APY for one year will grow to $10,400, not $10,000 plus $400 paid separately at the end.

What happens when your CD term ends

When your CD reaches its maturity date—the day the term ends—the bank sends you a notice, usually 10 to 14 days before. At that point, you have choices. You can withdraw all your money (principal plus interest). You can roll it into a new CD at whatever rate the bank is offering at that time. Or you can move the money to another bank or account.

If you do nothing, many banks automatically renew your CD for another term at the current rate. Read your CD agreement to see what your bank does. If you want to withdraw or move your money, you need to act before the maturity date or during the grace period the bank gives you—usually 7 to 10 days after maturity.

Once the money is in your account as regular funds, you can withdraw it without penalty. The CD contract is over.

Early withdrawal penalties and when they explore

If you need your money before the term ends, you can withdraw it, but the bank charges an early withdrawal penalty. This penalty is usually expressed as a number of months of interest. A CD with a three-month penalty means you lose three months' worth of the interest you would have earned.

On a $10,000 CD earning 4% APY with a three-month penalty, you'd lose about $100 in interest if you withdrew early. You'd get your $10,000 back, but the penalty comes out of the interest you've already earned or from your principal if you haven't earned enough interest yet.

Some banks offer no-penalty CDs, which let you withdraw your money early without losing interest. These CDs pay a lower rate than standard CDs because the bank can't count on having your money for the full term. They're useful if you think you might need the cash but want a better rate than a savings account offers.

FDIC insurance and what it protects

Money in a CD is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank. This means if the bank fails, the FDIC will return your money up to that limit. Your principal is protected, and so is any interest you've earned.

The $250,000 limit applies per bank, not per CD. If you have two CDs at the same bank totaling $300,000, only $250,000 is insured. If you want to insure more than $250,000, you'd open CDs at different banks.

This insurance does not protect you from the bank's interest rate changes or from your own decision to withdraw early. It only protects you if the bank becomes insolvent.

CD laddering and how it spreads your money across terms

Many people use a strategy called CD laddering to balance higher rates with access to their money. Instead of putting all your money into one 5-year CD, you split it into five CDs with different terms: one 1-year, one 2-year, one 3-year, one 4-year, and one 5-year.

Each year, one CD matures. You can then renew it for another 5-year term, or withdraw the money if you need it. This way, you earn rates close to what a 5-year CD would pay, but you get access to part of your money every year without paying an early withdrawal penalty.

Laddering works best when rates are stable or rising. If rates are falling, you might lock in higher rates on longer terms. If rates are rising, you want shorter terms so you can reinvest at better rates sooner.

How CD rates compare to savings accounts and money market accounts

CDs typically pay more interest than regular savings accounts or money market accounts at the same bank. The difference varies depending on the bank and the term. A 1-year CD might pay 4.0% while a savings account pays 0.5%. A 5-year CD might pay 4.5%.

The trade-off is access. A savings account or money market account lets you withdraw anytime without penalty. A CD locks your money away. If you don't need the cash for a set period, a CD usually makes sense. If you might need it sooner, a savings account is safer.

Online banks often pay higher CD rates than brick-and-mortar banks because they have lower overhead costs. Shopping around between banks can mean earning 0.5% to 1% more on the same term.

Frequently Asked Questions

Can I withdraw from a CD before it matures?

Yes, but you'll pay an early withdrawal penalty. The penalty is usually three to six months of interest, though it varies by bank and CD term. Some banks offer no-penalty CDs that let you withdraw without losing interest, though they pay a lower rate.

What happens to my CD when it reaches maturity?

The bank will notify you before the maturity date. You can withdraw your money, renew the CD for another term, or move it to another account or bank. If you do nothing, many banks automatically renew it at the current rate, so check your agreement.

Is my money safe in a CD if the bank fails?

Yes, up to $250,000. The FDIC insures CDs at member banks. Your principal and earned interest are both covered. If you have more than $250,000, only that amount is insured at each bank.

Why would I choose a CD over a savings account?

CDs pay higher interest rates because you agree to lock your money away for a set time. If you don't need the cash for months or years, a CD usually earns significantly more. If you might need the money sooner, a savings account is more flexible.

Do CD rates change after I open the account?

No. The rate you see when you open the CD is locked in for the entire term. It does not change if the bank raises or lowers its rates. When the CD matures, you'll get whatever rate the bank is offering at that time if you renew.