A certificate of deposit locks your money away for a set time in exchange for a may provide interest rate

A certificate of deposit (CD) is an agreement between you and a bank or credit union. You give them a sum of money—say $5,000—and agree not to touch it for a fixed period, called the term. In return, the bank pays you a fixed interest rate, usually higher than a regular savings account offers. When the term ends, you get your original money back plus the interest earned.

The bank uses your money during that time, which is why they pay you more than they would for a checking or savings account. You are essentially lending them money at a rate you both agree on upfront. The catch is that if you withdraw the money before the term ends, you pay a penalty—usually a loss of some or all of the interest you earned, or sometimes a percentage of the principal itself.

CDs come in different term lengths: 3 months, 6 months, 1 year, 3 years, 5 years, and longer. The longer the term, the higher the interest rate typically is, because the bank has your money locked in for a longer period. A 5-year CD will usually pay more than a 1-year CD, but you cannot access your money without penalty for five years.

Key Takeaways

  • You deposit a fixed amount of money for a fixed time period and receive a may provide interest rate that does not change.
  • Early withdrawal penalties vary by bank and CD type, but typically cost you some or all of the interest earned, or a percentage of your deposit.
  • The interest rate is higher for longer terms because your money is locked away for a longer time.
  • When the term ends, your CD matures and you can withdraw the money or roll it into a new CD at the current rate.
  • CDs are insured by the FDIC (at banks) or NCUA (at credit unions) up to $250,000 per account, making them very safe.

How interest rates and terms work together

The interest rate on a CD is set when you open it and does not change for the entire term, no matter what happens in the broader economy. If you buy a 2-year CD at 4.5 percent, you will earn 4.5 percent for those two years, even if rates drop to 2 percent or rise to 6 percent. This is the trade-off: you get certainty, but you also give up the chance to move your money if rates go up.

Banks publish different rates for different terms. Right now, a 6-month CD might pay 4.2 percent while a 5-year CD pays 4.8 percent. These rates change daily as banks adjust them based on what the Federal Reserve does and what other banks are offering. If you are comparing CDs, check the annual percentage yield (APY), which includes the effect of compounding and tells you the true return.

Some banks offer bump-up CDs or step-up CDs, which let you increase your rate once or twice during the term if rates rise. These usually start at a slightly lower rate than a standard CD, so you are paying for the flexibility. Others offer no-penalty CDs, which let you withdraw your money early without losing interest, but the rate is lower to start.

What happens when your CD matures

When your term ends, your CD matures. The bank sends you a notice a few weeks before, telling you what will happen next. You have a choice window—usually 7 to 10 days—to decide what to do with the money.

Your options are: withdraw the money in full, let it roll over into a new CD at the current rate (which may be higher or lower than your old rate), or move it to a different account at the same bank or a different bank. If you do nothing and your bank allows automatic renewal, your money will roll into a new CD at whatever rate the bank is offering at that time. Read the maturity notice carefully so you do not accidentally lock your money away for another term at a rate you do not want.

If you withdraw the money, the bank deposits it into your checking or savings account, or sends you a check. There is no penalty for withdrawing after the term ends—that is the whole point of waiting.

Early withdrawal penalties explained

If you need your money before the term ends, you can withdraw it, but you will pay a penalty. The penalty structure varies widely by bank and by CD type. Some banks charge a flat dollar amount—say $25. Others charge a percentage of your deposit, like 0.5 percent. Still others charge a loss of interest—for example, three months of interest, or all interest earned to date.

A few examples: If you have a $10,000 CD earning 4 percent APY and you withdraw after 6 months, you have earned about $200 in interest. A penalty of "three months' interest" would cost you $100. A penalty of "0.5 percent of principal" would cost you $50. A flat $25 penalty would cost you $25. The worst-case scenario is a penalty that wipes out all your interest and eats into your principal, though this is less common.

Before you open a CD, ask the bank what the early withdrawal penalty is. It is usually stated in the disclosure document you sign. Some banks post it on their website. If the penalty is very steep—say, a full year of interest—that is worth knowing before you commit your money.

Comparing CDs to other savings options

A CD is safest when you know you will not need the money for a specific period and you want a may provide return. If you might need the money sooner, a high-yield savings account is more flexible, though it usually pays a lower rate and the rate can change. A money market account sits between the two: it pays more than a regular savings account but less than a CD, and you can withdraw money without penalty.

If you are saving for something specific—a down payment in two years, a car in three years—a CD with a matching term makes sense. If you are building an emergency fund, a savings account is better because you need access without penalty. If you have money you will not touch for five years, a 5-year CD locks in a higher rate than you would get from a savings account.

CDs also differ from bonds and stocks: they have no market risk, meaning their value does not go up or down based on economic conditions. You get back exactly what you put in, plus the interest, as long as you wait until maturity. That safety comes at the cost of a lower return than you might get from investing in the stock market over the same period.

FDIC and NCUA insurance protections

Money in a CD at a bank is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per bank, per account type. Money in a CD at a credit union is insured by the National Credit Union Administration (NCUA) under the same limits. This means if the bank or credit union fails, you get your money back, up to $250,000.

If you have more than $250,000 to deposit, you can spread it across multiple banks or multiple account types at the same bank to stay within the insurance limit. For example, a $250,000 CD in your name and a $250,000 CD in a joint account with your spouse at the same bank are both fully insured because they are different account types.

This insurance is one reason CDs are considered very safe. You are not betting on the bank's health or the economy—you are may provide to get your money back, with interest, as long as the bank is FDIC-insured and you stay within the limits.

How to open a CD and what to watch for

Opening a CD is straightforward. You can do it online, by phone, or in person at a bank or credit union. You will need to provide your name, address, Social Security number, and the amount you want to deposit. You choose the term and the bank tells you the rate. You sign a disclosure document that spells out the term, the rate, the penalty, and what happens at maturity.

Before you open a CD, compare rates across banks. Online banks often pay higher rates than brick-and-mortar banks because they have lower overhead. Credit unions sometimes offer competitive rates to members. A CD paying 4.8 percent is worth more than one paying 4.2 percent, especially on a large deposit or a long term. Use a CD calculator to see the difference: on a $10,000 CD for one year, the difference between 4.2 and 4.8 percent is about $60.

Watch for these details: the exact penalty amount or formula, whether the rate is fixed or variable (it should be fixed), whether the CD renews automatically, and whether there are any fees beyond the early withdrawal penalty. Some banks charge monthly maintenance fees on CDs, though this is rare. Read the fine print so you know exactly what you are getting into.

Frequently Asked Questions

Can I withdraw money from a CD before it matures?

Yes, you can withdraw money anytime, but you will pay an early withdrawal penalty. The penalty varies by bank and CD type—it might be a flat fee, a percentage of your deposit, or a loss of interest. Check your CD's terms before you open it so you know what the penalty is.

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

A savings account has no term and no penalty for withdrawal, but it pays a lower interest rate that can change anytime. A CD locks your money for a set time at a fixed rate, but you pay a penalty if you withdraw early. Choose a CD if you will not need the money for a specific period; choose a savings account if you need flexibility.

What happens if the bank fails while I have a CD?

The FDIC or NCUA insurance protects your money up to $250,000. You will get your full deposit plus any interest earned, even if the bank goes out of business. This is one reason CDs are considered very safe.

Should I buy a longer-term CD if rates are high?

If you believe rates will drop, a longer-term CD locks in the higher rate for longer. If you think rates will rise, a shorter-term CD lets you reinvest at a higher rate sooner. No one can predict rates with certainty, so choose a term that matches when you will actually need the money.

Can I move money from one CD to another without a penalty?

Only after your CD matures. If you withdraw before maturity to move the money to a different CD, you pay the early withdrawal penalty on the first CD. After maturity, you can withdraw and open a new CD at a different bank with no penalty.