What Is a Certificate of Deposit and How Does It Work
Not every savings tool is meant to be touched whenever the mood strikes, and a certificate of deposit is built around that trade-off on purpose.
In a nutshell
A certificate of deposit, usually called a CD, is a type of savings account offered by banks and credit unions where money is deposited for a fixed term, ranging anywhere from a few months to several years, in exchange for a set interest rate that generally doesn’t change for the life of the term. In return for locking the money away, CDs generally offer a higher rate than a standard savings account, though the exact gap varies over time and by institution. The trade-off is access: withdrawing funds before the term ends typically triggers a penalty.
How the term works
Once money is deposited into a CD, it’s generally expected to stay there until the maturity date, which is the day the term ends. During that period, the interest rate is typically locked in, meaning it won’t rise or fall even if rates elsewhere in the economy move. This is different from a high-yield savings account, where the rate can be adjusted at any time by the bank. When the term ends, the CD is said to mature, and the account holder can withdraw the original deposit plus the interest earned, or in many cases roll it into a new CD.
As an illustration, a $1,000 deposit into a one-year CD earning a hypothetical 4% would grow to about $1,040 by maturity, assuming the interest compounds over the term and no withdrawals are made along the way. The actual math depends on how often interest compounds and the specific term chosen.
Early withdrawal penalties
The defining feature of a CD is what happens if the money is needed before the term is up. Most CDs charge an early withdrawal penalty, commonly structured as a forfeiture of some amount of interest, such as a few months’ worth, rather than a flat fee. On longer-term CDs, that penalty is often larger. In some cases, if a CD is cashed out very early, the penalty can eat into the original deposit itself, not just the interest earned, so it’s worth reading a CD’s specific terms before opening one.
How CDs compare to other accounts
A CD sits in a different spot than most everyday accounts:
- Versus a savings account. A regular savings account generally allows withdrawals at any time without penalty, while a CD trades that flexibility for a typically higher, locked-in rate.
- Versus a checking account. Checking accounts are built for frequent transactions and generally earn little to no interest, while a CD is built to sit untouched.
- Versus a money market account. A money market account typically allows ongoing access to funds, sometimes with check-writing or debit features, whereas a CD does not offer that kind of access during its term.
Choosing a term
CD terms are typically offered in standard lengths, such as three months, six months, one year, or several years, and the rate offered often varies by how long the term is. Choosing a term generally means weighing how soon the money might be needed against how much of a rate difference longer terms offer at the time. Money that’s part of an emergency fund is often better suited to an account with no withdrawal restrictions, since the whole purpose of that money is to be accessible without penalty when something unexpected comes up.
Like most deposit accounts at banks and credit unions, CDs are generally covered by FDIC insurance or the credit union equivalent, up to the applicable limits, which protects the deposit itself regardless of what the account is called.
Worth remembering
A CD is essentially a deal: a fixed rate for a fixed period, in exchange for giving up easy access to the money until it matures. That structure can suit money that has a known timeline and doesn’t need to be touched, but it’s a poor fit for funds that might be needed on short notice.