What Is a CD?

Certificate of Deposit Definition

A certificate of deposit (CD) is a type of savings account that usually offers a relatively high yield but requires you to keep your funds invested for a fixed period of time. The term length ranges from a few months to several years, and if you withdraw your money early, you will likely incur penalty fees. CDs are generally used to lock in predictable returns and preserve capital.

How Do CDs Work?

CDs work like a savings account, you deposit money and accrue interest, but if you withdraw the funds before a predetermined length of time, you will likely incur penalties. CDs typically offer a fixed interest rate that remains constant throughout the term.

• Your initial deposit is the only one: Your initial deposit is also your principal for the life of the investment. Unlike with regular savings accounts, you cannot make additional deposits whenever you want to.

• CD rates are fixed over the term length: The interest rate offered on a CD remains fixed throughout the entire term. You will earn the same interest rate on your investment until the CD reaches maturity.

• CDs have relatively higher interest rates: One of the primary advantages of a CD is the higher interest rates they offer compared to standard savings accounts. This makes CDs attractive for people who would like to maximize their earnings on a predetermined amount of money.

• You must pay a penalty to withdraw early: When you invest in a CD, you commit to keeping your funds with the financial institution for the agreed-upon term. If you decide to withdraw the money before the CD matures, you will typically face a penalty. The penalty can be a portion of the interest earned or a fee.

• Insured by the Government: Certificates of deposit are considered low-risk investments because they are backed by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). These organizations insure deposits up to $250,000 in case the bank or credit union fails.

How to Get a CD

You can get a CD by researching and comparing your options, choosing the maturity date and type of CD that fits your investment needs, then visiting a bank or credit union in person or online. You may need to provide personal information such as your name, address, contact information, and Social Security number.

Note, many CDs have a minimum requirement of $500 to $1,000, while some do not have any minimum investment.

1. Choose a Type of CD

Decide on the type of CD that aligns with your financial goals. Consider factors such as the term length, the interest rate, and any specific requirements or features.

2. Select a Financial Institution

Once you have identified a suitable CD, select a financial institution. This can be a bank, credit union, or brokerage firm.

3. Contact the Financial Institution

Contact the CD provider you choose, either by visiting a location in person or online. Some banks may require an in-person visit to open an account, but a number of online options exist.

4. Verify Your Identity and Complete the Paperwork

You will have to provide the necessary documents to confirm your identity, address and Social Security number as well as complete the necessary account forms.

5. Confirm the Terms and Conditions

Review the terms and conditions of the CD agreement, including the interest rate, maturity date, and penalties for early withdrawal. Clarify any issues with the financial institution.

6. Fund the CD

Transfer the funds for your CD from your existing bank account or make a deposit in person.

Best CDs to Get

You can compare CD rates and learn more about the best options here at WalletHub.

Types of CDs

Traditional CDs involve depositing money for a specified time frame, ranging from a few months to several years, and receiving compensation in the form of interest that accumulates at a fixed rate until maturity. However, there are several types of CDs with different features, fees, benefits and downsides.

No penalty CD: Unlike most CDs, a no penalty CD allows you to withdraw funds before the maturity date without incurring any penalties. This type of CD provides flexibility and liquidity, making it suitable for people who may need access to their funds before the CD term ends. Because of this added benefit, no penalty CDs may have a lower interest rate than CDs that do not allow early withdrawals.

High-yield CD: A high-yield CD offers a higher interest rate compared to standard CDs. It is designed to provide greater potential earnings on your investment. High-yield CDs are often offered by online banks or credit unions and may require a larger initial deposit.

IRA CD: An IRA CD is specifically for retirement savings within an Individual Retirement Account (IRA). It provides the tax advantages associated with IRAs while offering the security and fixed interest rates of a CD. Contributions to IRA CDs are subject to annual limits set by the government.

Bump-up or step-up CD: A bump-up or step-up CD allows you to request an increase in the interest rate during the CD term. This feature can be advantageous if interest rates rise after you've purchased the CD. However, bump-up or step-up CDs often start with a lower initial interest rate compared to standard CDs.

Brokered CD: This kind of CD is purchased through a brokerage firm rather than directly from a bank. Brokered CDs can offer a wider range of options from different banks and other financial institutions, allowing you to diversify your CD investments. However, they may also involve additional fees or commissions.

Jumbo CD: A jumbo CD requires a large minimum deposit, typically starting at $100,000 but less in some cases. In return, jumbo CDs usually offer higher interest rates than regular CDs. These CDs are suited for individuals with a significant amount of money to invest.

It's important to note that the specific terms, interest rates, and conditions associated with CDs can vary between financial institutions.

You can learn more about the best CD rates here at WalletHub.

Are CDs Worth It?

In general, CDs are worth it when:

• You Want Higher Interest Rates Than a Traditional Savings Account: When interest rates are relatively high, CDs become more attractive. By locking in your money for a specific period, you can benefit from a higher yield compared to savings accounts or other low-risk investments. 

• You Have a Low Risk Appetite: CDs are considered low-risk investments because they are insured by the FDIC and NCUA. If you prioritize capital preservation and want to avoid market volatility, CDs can be a secure option.

• You Need Predictable Returns: If you have a specific time frame in mind for your savings goals, such as a down payment for a house in five years, a CD can provide a fixed-term investment option.

It’s important to weigh the risk versus the reward when you’re considering investing in a CD. Certificates of deposit are a low-risk investment because they are government-insured, they guarantee your principal is returned, and they provide a predictable yield. However, you give up liquidity and the potential for higher earnings from riskier investments like stocks, bonds, mutual funds, and real estate. Also, if rates rise, inflation could reduce the value of your money.

It's best to evaluate the current interest rate environment, compare different savings options, and consider your personal needs before making a decision. Consulting a financial advisor is a wise move, too.