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If you're looking to save your money, you should consider using a Certificate of Deposit, or CD account. CDs are increasingly popular and for good reason. They are savings funds that promise a higher, fixed rate of interest, in exchange for locking your money away for specific amounts of time.
Here’s everything you need to know about choosing a CD.
Key Insights
- A CD may be right if you can lock funds for a fixed term and prioritize higher, fixed rates with FDIC insurance.
- When choosing a CD, compare rates, terms, and penalties; longer terms offer higher rates but more risk.
- Consider specialty CDs like IRA, jumbo, bump-up, or add-on CDs for unique features.
- Be aware CDs may roll over automatically at maturity unless you instruct otherwise.
Is a CD the Right Savings Option for You?
The first thing to decide is whether a CD is really the best option for your savings. On the one hand, CDs generally offer a higher rate of interest than standard savings accounts and come with the added benefit of FDIC insurance so that even if the bank or credit union fails, you won't lose your money.
However, some people find it difficult to lock their money away for a specific period of time. If you are one of them, you might prefer a savings account or money market account, which gives instant access to your cash. You also can't top up a CD on a regular basis, and usually can't easily switch to a higher interest rate if rates go up. If any of these are important factors for you, you might prefer a different type of savings fund.
Once you’re sure that you want a CD, it’s time to choose the best one for you. Most banks and credit unions offer at least one CD, so it’s important to do your research, compare rates and terms carefully, and think hard to know how to choose a CD.
What to Look for in a CD
Before you start comparing CDs, think about how much you want to save, and for how long. Most CDs have stepped interest rates, so you won’t get the best rate unless you invest a certain amount. $25,000 is a standard high CD balance, but you can often access the best rate for just $1,000 or less.
Interest Rates
Naturally, you want the highest interest rate you can find. CD interest rates can vary wildly between banks and credit unions, so don’t cut your research short. Online CDs often have much higher interest rates than those offered by traditional banks and credit unions, and some banks give you a higher rate if you are an existing customer.
CD Term
In general, the longer the savings term, the higher the interest rate, so look for CDs with a longer-term. Some CD terms are as long as ten years, but one year, three years and five years are the most common. Although you want a long term to enjoy better interest rates, don't ignore the risk of early withdrawal penalties. If you can't leave your money for five years and end up paying the penalty for early withdrawal, you could end up with less than if you'd invested in a one-year CD and rolled it over each year.
Don’t get hung up on a specific term. Some banks and credit unions offer odd terms, like 17 months or 13 months, as a promotional gimmick or to celebrate their anniversary. These can come with much better rates, so look out for odd length terms.
Some financial advisors recommend laddering your CDs. This means that you divide your investment amount into five, and invest one portion in a one-year CD, one in a two-year CD, and so on. Then, when the first CD matures at the end of one year, you invest that amount in a top-rate five year CD.
You do the same the following year with the amount from your two-year CD, and so on, until you have five five-year CDs, each one maturing every 12 months. This way, you get the top rates from a five-year CD, but you can access your money every 12 months, so if you need the cash, you won't have to wait too long.
Early Withdrawal Penalties
Even if you’re sure that you won’t need to touch your CD principal until the end of the term, always compare the early withdrawal penalties. You can’t foresee the future, and you might end up needing to cash in a CD early.
Most banks and credit unions charge a specific number of months’ interest as a penalty, but some charge a fixed percentage. If you only just opened the CD recently and haven’t had time to earn much interest, this could mean that you don’t even get back the amount you deposited, so always compare early withdrawal penalties.
There are some CDs that come without early withdrawal penalties, but as you would expect, you’ll get a lower interest rate.
Default Action on Maturation
Another important question to ask when selecting a CD is what happens when your CD matures. Usually, you'll hear from the bank or credit union a few months before maturation, asking what you'd like to do with the maturing funds. Typically, your options will be:
- Roll your CD over into a new CD with the same bank or credit union. The institution will generally suggest a similar CD, like another 12-month CD, but you can request that they transfer it into a new CD with a much longer or shorter term.
- Transfer your savings to a new account at the same bank or credit union, like a standard savings, checking, or money market account.
- Withdraw your savings entirely. You can ask for the funds to be transferred electronically to a different bank account or mailed to you as a paper check, and then choose to spend it or invest it elsewhere.
If you miss the maturity date and you don’t send any instructions for what to do with your funds, the bank or credit union will have a default course of action. Usually, the default action is to roll it over to a new CD, which means that the money will be locked in for another term unless you pay early withdrawal penalties.
Specialty CDs
As well as standard CDs, you can also choose between specialty CDs that have unique terms and conditions. Here are some popular specialty CDs to consider:
- IRA CDs, which offer a CD as part of an IRA vehicle. This helps you to save on tax and maximize your IRA allocations. Some banks and credit unions have special IRA CDs, while others allow you to set up any CD as an IRA.
- Jumbo CDs are regular CDs that offer a higher rate in exchange for a much larger minimum deposit amount. There’s no fixed minimum for a Jumbo CD, but most banks set it at $50,000.
- Bump-up CDs also called raise your rate CDs, allow you to raise your interest rate to a higher rate once, or on rare occasions twice during the term. They are a good option if you think that interest rates might go up, but still want the security offered with a fixed interest rate.
- Add-on CDs give you the option of adding to your deposit after you’ve opened the CD. Some banks and credit unions let you make extra deposits as often as you want, while others have a certain number of extra deposits per quarter or per month, and some allow a certain number of extra deposits throughout the term.
Compare CDs to Find the Best One for Your Money
It can be tough to know just how to choose a CD for your needs, but when you take the time to really think about what you want out of your CD and go online to compare rates, terms, and conditions between different CDs, you can find the right CD for your savings.
Still can't decide? Feel free to check out more online banks to discover the best Online Banking company for you.
Written bySarah Pritzker
Sarah Pritzker is an insurance expert at BestMoney.com, specializing in pet, life, and home insurance. With years of experience covering online consumer products, she leverages her in-depth knowledge to help readers navigate today’s complex financial landscape.