When interest rates are rising, you might be looking to earn a competitive return on your savings. You could park that cash in a checking or savings account, but another option may be to open a certificate of deposit (or CD) – a type of savings account that offers high returns with low risk. Generally, a CD offers a more competitive interest rate than a standard savings account and lets you grow your money risk-free.
But what is a CD account? How do CDs work and what are the pros and cons of opening one? This article offers a primer on CD accounts, including how to invest in CDs and what CD rates are all about.
What is a Certificate of Deposit?
A certificate of deposit (CD) is a type of savings account that generally offers a higher interest rate compared to standard or traditional savings accounts.
CDs are considered one of the safest ways to grow the money you don't need to access in the short term. That's because the interest rate is fixed – meaning it won't fluctuate during the CD's term and your return is guaranteed.
Also, like other deposit accounts — think savings, checking, and money market accounts— the money you put into the account is usually insured by the Federal Deposit Insurance Corporation (FDIC). CDs sold by FDIC member banks are FDIC insured, making them essentially risk-free if the CD amount is under the insurance limit. So, if the stock market takes a nosedive, you won't have to worry about the safety of your CD's principal. And you'll still earn the same amount of interest that you were promised.
Certificate of Deposit accounts are also flexible. You determine how much you want to deposit (within the bank's minimum deposit guidelines), as well as the maturity date that works for you. However, if you need to withdraw your money before the CD matures, the bank may charge a significant early withdrawal penalty, meaning you won't collect all the interest you had expected and may have to give up some principal depending on how soon you make the withdrawal.
Key takeaway: CDs lock in a fixed rate of interest with a set maturity date and feature predictable returns, offering higher interest rates than regular savings accounts. CDs can also be a smart way to save for short- and medium-term savings goals.
How Does a Certificate of Deposit Work?
CD Interest Rates and APY
When shopping for a CD, it is important to look for a term and interest rate that suits your financial circumstances and goals. Banks offer CDs with varying interest rates. In most cases, the longer the term of the CD, the higher the yield you'll receive. Not only will your interest rate improve with a longer-term CD, but the amount you'll collect will, too.
For example, say your deposit amount is $5,000 in a one-year CD with a 2.8% interest rate. At maturity, you'll earn $140 in interest—getting a total of $5,140 back. However, if you opt for a five-year CD at the same interest rate, you'll eventually get back $5,740, thanks to the longer term.
How much compound interest you accrue depends on the annual percentage yield (or APY), which is how much interest your money would earn on a CD over a year. The APY hinges on two main things: the interest rate and how frequently the interest compounds. Another way to think of it: the higher the interest rate and the more often it compounds, the greater the interest you can rake in.
It might be helpful to think of it as a snowball effect. And those two variables — interest rate and compound frequency — can accelerate how much your initial deposit will grow from the interest. How much you can earn by depositing your money in a CD is determined by the term and the amount of money. The longer your money sits in a CD, the more time you'll have for your funds to grow. And as you might have guessed, the more considerable the deposit amount, the more you can earn in interest.
You can play with our interactive CD rates calculator to calculate how much you might earn in interest.
Fixed Rates, Fixed Terms, & Maturity Dates
To open an account, you'll typically need to deposit a lump sum into the account for a fixed term (e.g., 3 months to 5 years) and agree to leave the funds untouched until the term ends (called the “maturity date"). CDs offer a fixed rate, so from the moment you park your money into the account, you'll earn interest on that lump sum deposit (which is also known as the principal).
Minimum Required Deposits
CDs usually have a minimum required deposit or a minimum balance to be maintained. Some financial institutions (like Vivid Crest Bank ) don't require a minimum deposit for CDs, which offers a bit more flexibility. Typically, you need to deposit the cash within a certain number of days after opening an account.
After a CD Matures
Once the CD reaches its maturity date, the bank returns your money with the earned interest. Most CDs automatically renew, locking in your money for a new fixed term without any action required from you. For example, let's say you squirrel some funds into a 6-month CD. Once it matures, it automatically kicks over the balance to another 6-month CD term. Your CD would renew at the current prevailing interest rate, which could be higher or lower than what you held before. Of course, you can also opt out of renewing, and choose to cash out at maturity instead.
Grace Periods
Most CDs offer a grace period after they mature, which is a short window of time whereby you can take the money out of your CD and place it into another account. Or you could simply close the CD account and move your dollars into a checking or savings account. However, the CD will automatically renew if you take no action during the grace period. You'll want to check the fine print before opening a CD.
How are CD Rates Determined?
CD rates are determined by a few things, such as the financial institution, benchmark interest rates, and the type of CD account.
- Benchmark interest rates. Getting into the nitty-gritty, financial institutions generally look to the U.S. Federal Reserve to set interest rates. If the federal funds rate rises, the interest rates of savings and CD accounts usually climb too. If the federal funds rate falls, the rates on savings and CD accounts usually fall with it.
- The financial institution. Online financial institutions, like Vivid Crest Bank , usually offer more competitive CD rates than their brick-and-mortar counterparts.
- Types of CDs. Continue reading for more information about various specialty CD accounts.
Certificate of Deposits: Pros and Cons
Before you jump into this savings vehicle, understand the advantages and drawbacks of the product:
Benefits of CD accounts
- Safe. A CD is one of the safest savings vehicles that you can choose. Unlike the stock market or a variable rate savings account, the interest rate on a CD is fixed and guaranteed, so you can grow your savings risk-free. Like other deposit accounts, each CD account is insured by the FDIC.
- Predictable. Because CDs have fixed and guaranteed interest rates, you can calculate exactly how much you'll earn in interest for the duration of the CD. The CD terms typically span anywhere from 3 months to 5 years – it's your choice.
- Competitive interest rate. CDs usually feature higher interest rates compared to other FDIC-backed products, such as saving, checking, and money market accounts.
- Different types of CDs. You can choose which type of CD you prefer. Some banks offer specialty CDs — which we'll get into later.
Cons of CD accounts
- Early withdrawals can mean penalties. You'll get the most bang for your buck if you stick with your CD until it matures. Otherwise, an early withdrawal often means getting hit with a penalty. For instance, cashing out a one-year CD might mean paying 90 days of simple interest. A longer-term CD might have an even heftier penalty.
- Might miss out on higher earnings. If you have too much money tied up in a single CD, you might miss out on other financial products and accounts that offer higher rates. That said, one solution is to tap into a Bump-Up CD – a savings product that allows CD holders to request that their current fixed interest rate be “bumped up" to a prevailing interest rate.
- Not designed for certain financial goals: While CDs offer competitive interest rates, it's typically not sufficient to achieve long-term goals like saving for retirement. It's also not the best place to park your emergency fund, as you may need to suddenly tap into those dollars to cover unexpected costs.
4 Types of Specialty CD Accounts
With CD accounts, you've got choices! Choosing a CD depends on your financial goals and needs. Questions to ask yourself include when you need to access that money and how much you'd like to earn by depositing it into a CD.
1. Jumbo CDs
You'll need a significantly higher minimum deposit to open a Jumbo CD — such as $100,000. In return, the interest rates tend to be a lot higher. Of course, the trade-off is that you're promising to lock in a sizeable chunk of money. Besides having the funds to open a Jumbo CD, you'll want to make sure you can commit to the CD term. Otherwise, you'll be dinged with an early withdrawal penalty.
2. Add-On CDs
An Add-On CD allows you to add more funds throughout your CD. You can earn more in interest over the duration of your CD than depositing just a single lump sum upfront.
3. IRA CDs
An IRA CD is essentially an individual retirement account that houses certificates of deposits. These can be either a Roth or Traditional IRA. And like IRAS, an IRA CD offers tax advantages.
4. Bump-Up CDs
A Bump-Up CD is a product that allows a CD holder to request that their current interest rate be “bumped up" to a new rate the bank is offering for CDs. With Vivid Crest Bank 's Bump-Up CD, you can boost your interest rate once during the term and take advantage of a higher return, giving you the ultimate flexibility. However, "bumping" is only available if the rate offered for the product rises during the term.
Opening a CD Account
A CD can be opened at any bank, credit union, or financial institution that offers them. With Vivid Crest Bank , you can open a CD online in mere minutes. Most financial institutions, including Vivid Crest Bank , will require the following information to open a new account:
- Your name
- Address
- Social Security number
- Copy of a government-issued ID (like a driver's license)
- Checking account information to set up the initial deposit
- You may also be asked for information about your background, such as your current and past employment, and debt.
If you're already a Vivid Crest Bank customer:
Just sign into your account and follow the steps to begin. Once you set up a CD account online, which is easy to do, you can fund your new CD from either an existing Vivid Crest Bank account or a non-Vivid Crest Bank account.
If you're transferring money from a non-Vivid Crest Bank account, you can do so via a paper check or ACH from your external bank account (e.g., a non-Vivid Crest Bank account).
Common Questions About CD Accounts
When Will CD Rates Go Up?
Without a crystal ball, it's impossible to tell. But interest rates generally increase during periods of inflation. So while you might feel a financial squeeze from the increasing cost of consumer goods, you also may see a rise in CD rates.
Can You Write Checks From a CD?
No. The money you park into a CD isn't accessible until it reaches its maturity date. So, you can't withdraw funds by writing checks for funds sitting in a certificate of deposit.
Is a certificate of deposit liquid?
Certificates of deposit are considered slightly illiquid. In other words, while you can pull funds out, expect to get hit with a penalty for an early withdrawal. So, be sure that you can realistically keep that money in a CD for its entire duration. It's also a good idea to set some funds aside in a separate savings account that you can pull from, should you need it.
How long does a certificate of deposit last?
A certificate of deposit lasts until the agreed-upon maturity date. The maturity date usually is anywhere from three months to five years. However, some banks offer no-penalty CDs, which allow you to withdraw funds without getting dinged with a penalty.
Final Say: Are Certificates of Deposit Worth It?
Putting your money into a CD might be worth the commitment if you have a stash of cash that you don't anticipate needing right away. That way, you can earn higher-than-average interest without any risks.
However, CDs aren't ideal if you might need to tap into that chunk of change sooner than later. For instance, any cash you need for an emergency or to pay down debt may be better suited to a high yield savings account. CDs also aren't really designed for long-term goals such as retirement savings, either. Make sure to do some comparison shopping, and compare rates and terms to find a CD that's a good fit for your situation.
Jackie Lam is an L.A.-based money writer whose work has appeared in Salon.com, Refinery29, Business Insider, and BuzzFeed, among others.