What Is a Certificate of Deposit (CD)?
Summary
- A certificate of deposit, or CD, lets you earn interest by leaving money in an account for a set period of time.
- CDs typically offer a higher interest rate than a standard savings account in exchange for limiting access to your money during the term.
- When a CD reaches maturity, you can generally withdraw the money or choose another savings option.
- Withdrawing money before maturity can result in penalties or fees, so your timeline matters when choosing a CD.
A certificate of deposit can be a useful savings option when you have money you do not expect to need right away. In exchange for keeping your deposit in the account for an agreed-upon period, the financial institution pays interest on your money. Understanding a few basic terms can make it easier to decide whether a CD fits your savings goal and timeline.
How a CD Works
When you open a CD, you deposit money for a specific period, known as the term. The amount you deposit is the principal. The date the term ends is the maturity date.
CD terms can vary. The interest rate and annual percentage yield, or APY, help determine how much your deposit can earn during the term.
The tradeoff is access. A CD is designed for money you can leave in place until maturity. If you withdraw money early, the financial institution may charge a penalty or fee.
What Happens When a CD Matures?
When your CD reaches its maturity date, you generally have a limited period to decide what to do next. Depending on the financial institution and account terms, you may be able to withdraw the money, move it to another account or reinvest it in another CD.
If you do not take action during the available window, the financial institution may automatically renew the CD for another term at the rate available at that time. Reviewing the maturity instructions and renewal terms can help you avoid an unexpected renewal.
How CDs Earn Interest
Interest is the money a financial institution pays you for keeping your deposit in the account. With simple interest, earnings are calculated only on the original principal. With compound interest, previously earned interest is added to the balance and can also earn interest.
CDs commonly use compound interest. The APY reflects the effect of compounding and can help you compare how different deposit products may grow over time.
Benefits and Tradeoffs of CDs
CDs can offer a predictable way to earn interest while keeping your money in a deposit account.
Potential benefits include:
- The opportunity to earn a higher yield than a regular checking or savings account.
- A choice of terms that can help you match the account to your savings timeline.
- A stated interest rate for the term on fixed-rate CDs.
- Federal deposit insurance when the CD is held at an insured financial institution, subject to applicable coverage limits.
The main tradeoff is liquidity, or how easily you can access your money. Taking money out before maturity can reduce the interest you earn and may result in additional penalties, depending on the account terms.
Interest-rate changes can also affect your decision. If market rates rise after you open a fixed-rate CD, your money remains at the rate you agreed to for the term. If market rates fall, that same fixed rate may work in your favor.
Is a CD Right for Your Savings Goal?
A CD may be worth considering when you have money you can set aside for a defined period and want to earn interest without taking on market risk. Before opening one, compare the term, APY, minimum deposit, early withdrawal rules and what happens at maturity.
If you expect to need the money sooner, a shorter CD term or a more accessible savings option may better match your needs. The right choice depends on your goal, timeline and how much access you want to keep to your savings.