What a Certificate of Deposit Is and How You Use It

A certificate of deposit (CD) is an account where you give a bank or credit union a sum of money for a set period of time, and in return they pay you interest. You cannot withdraw the money before that time ends without paying a penalty — that restriction is what makes the bank willing to pay you more interest than a regular savings account would.

The trade-off is straightforward: you lock up your money, and the bank locks in a higher interest rate for you. If you need the money before the CD matures (the date the term ends), you lose some or all of the interest you earned, and sometimes a portion of your principal too. If you leave it alone until maturity, you get the full interest payment.

CDs are insured by the FDIC (Federal Deposit Insurance Corporation) up to $250,000 per account holder per bank, so your money is protected even if the bank fails.

Key Takeaways

  • You deposit money for a fixed term — typically three months to five years — and cannot touch it without a penalty.
  • The interest rate is locked in when you open the CD and does not change, even if rates rise or fall.
  • Early withdrawal penalties vary by bank and term length; some banks charge a flat fee, others charge months of lost interest.
  • When your CD matures, you can withdraw the money, open a new CD, or let it roll over into another CD at the bank's current rate.
  • CDs are FDIC-insured up to $250,000, making them one of the safest places to keep money.

How Interest Rates and Terms Work on a CD

When you open a CD, you choose a term length — the period of time your money stays locked in. Common terms are three months, six months, one year, two years, three years, and five years. The longer the term, the higher the interest rate the bank typically offers, because they get to hold your money for longer.

The interest rate you receive is fixed, meaning it does not change for the life of the CD. If you open a two-year CD at 4.5%, you will earn 4.5% for the full two years, regardless of whether market rates go up to 5% or down to 3%. This is different from a savings account, where the rate can change at any time.

Interest on a CD is usually compounded daily or monthly, meaning the interest you earn gets added to your balance, and then you earn interest on that interest. The bank will tell you the APY (annual percentage yield), which shows you the total return you will get in one year, accounting for compounding.

What Happens When You Withdraw Money Early

If you need your money before the CD matures, you can withdraw it, but you will pay an early withdrawal penalty. The penalty amount varies widely by bank and by the CD's term length. Some banks charge a flat fee (like $25), while others charge a certain number of months of interest (like three months of interest, or six months of interest).

For example, if you have a $10,000 CD earning 4% APY and you withdraw after six months instead of waiting the full year, your bank might charge you six months of interest as a penalty. That means you would lose roughly $200 in interest, and you would receive about $9,800 instead of the $10,200 you would have gotten at maturity.

Before you open a CD, ask your bank what the early withdrawal penalty is. This information is required to be in the disclosure they give you, but it is worth understanding upfront so you know what it costs if your situation changes.

What Happens When Your CD Matures

When your CD reaches its maturity date, the bank will notify you (usually by mail or email) that the term is ending. At that point, you have a few options: you can withdraw the money in full, you can open a new CD with the same bank, or you can let the CD roll over.

If you do nothing, many banks will automatically roll over your CD into a new one at the bank's current rate. This means your money stays locked in for another term of the same length, but at whatever interest rate the bank is offering at that moment. If rates have dropped, your new rate will be lower. If rates have risen, your new rate will be higher.

Most banks give you a grace period (often 7 to 10 days) after maturity during which you can withdraw your money without penalty if you do not want to roll over. Check your maturity notice to see what your bank's grace period is, because if you miss it and the CD rolls over, you will have to pay the early withdrawal penalty to get your money out.

How to Open a CD

Opening a CD is straightforward. You go to your bank or credit union in person, call them, or visit their website. You tell them you want to open a CD, choose your term length, and decide how much money to deposit (most banks have a minimum, often $500 or $1,000, though some have no minimum).

The bank will show you the current interest rate for that term and give you a disclosure document that explains the rate, the term, the early withdrawal penalty, and what happens at maturity. Read this document carefully, because it is the contract that governs your CD. Once you sign, the CD is open and your money is locked in.

You can open a CD with money from a checking or savings account at the same bank, or you can transfer money in from another bank. Some banks also allow you to open a CD online without visiting a branch.

CD Laddering: A Strategy for Accessing Your Money

One way to get around the lock-in problem is to use a strategy called CD laddering. Instead of putting all your money into one CD with a long term, you split it into several CDs with different maturity dates.

For example, if you have $5,000 to invest, you might open five $1,000 CDs: one with a one-year term, one with a two-year term, one with a three-year term, one with a four-year term, and one with a five-year term. Each year, one CD matures. You can then withdraw that money if you need it, or roll it into a new five-year CD to keep the ladder going.

This approach gives you regular access to portions of your money while still locking in higher rates for the longer terms. It requires more effort to set up and manage, but it is a popular strategy for people who want the safety and rates of CDs but also want some flexibility.

CDs Versus Savings Accounts and Money Market Accounts

A regular savings account has no lock-in period — you can withdraw money whenever you want. In exchange, the interest rate is lower and can change at any time. A CD pays more interest but requires you to leave the money untouched for the full term.

A money market account sits in the middle. It typically pays more interest than a savings account but less than a CD, and it usually allows you to make a limited number of withdrawals per month without penalty. Money market accounts are useful if you want better returns than savings but need occasional access to your money.

Choose a CD if you have money you know you will not need for several months or years. Choose a savings account if you need to access your money frequently. Choose a money market account if you want something in between.

Frequently Asked Questions

Can I withdraw money from a CD before it matures?

Yes, you can withdraw early, but you will pay an early withdrawal penalty. The penalty is set by your bank and is disclosed when you open the CD. It typically ranges from a flat fee to several months of lost interest. Check your CD agreement to see the exact penalty before you open it.

What is the difference between APR and APY on a CD?

APR (annual percentage rate) is the interest rate without accounting for compounding. APY (annual percentage yield) includes the effect of compounding — the interest you earn on your interest. Banks must show you the APY, which is the number that matters for comparing CDs.

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

Your CD is protected by FDIC insurance up to $250,000. If the bank fails, the FDIC will pay you the full balance of your CD plus any interest earned up to the insurance limit. This makes CDs one of the safest places to keep money.

Can I move my CD to a different bank?

You can withdraw your money and move it to another bank, but if your CD has not matured yet, you will pay the early withdrawal penalty. Some banks offer CD transfers where another bank takes over your CD without penalty, but this is rare. Ask your bank if they offer this option.

What happens if interest rates go up after I open my CD?

Your CD rate stays the same — it is locked in for the full term. If rates rise, you will not benefit until your CD matures and you can open a new one at the higher rate. This is the trade-off of a fixed-rate CD: you are protected if rates fall, but you do not gain if they rise.