How Do CDs Work? Start Stacking Your Savings

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No one wants to lose money or invest poorly. Though there are no guarantees, investing in a certificate of deposit has fewer risks than investing in stocks and slightly higher rewards than a standard savings account or money market account. 

How Does a CD Work?

A CD is a type of savings account. When you open a CD, you agree to leave money in the account for a specific period of time. Over that period, the money earns interest, which you can withdraw at the end of the term.

How CDs Work: Step-by-Step

CDs are essentially time deposit accounts that pay a fixed interest rate over a period of time which, on average, ranges from a few months to five years. Given the set term lengths, any early withdrawals of funds before the fixed maturity date come with a penalty fee.

Here is a breakdown of how CDs work in three easy steps:

1. Deposit your money into a CD account.
2. Agree not to make any withdrawals for the length of the CD term.
3. When the term ends and the account is matured you get your money plus whatever was earned in interest back.

Good To Know

CDs offer important benefits, such as:

• Interest: CD accounts earn compounding interest. That means interest is added to the principal, and you earn interest on your interest over the course of the CD term.
• Low risk: CDs don’t fluctuate. As long as you keep your money in one, you’re guaranteed the interest.
• Government guarantee and insured: CDs are FDIC insured, as long as the bank that issues them has FDIC insurance. This is the same protection that savings accounts, money market accounts and checking accounts offer.
• Steady returns: Some CDs pay a very competitive rate, especially when compared with other guaranteed accounts such as savings accounts.

Why Choose CDs?

CDs are considered one of the safest forms of investment. Other key features of CDs include:

• Predictable income. Fixed-rate CDs earn at a locked-in interest rate for the entire term.
• Higher interest rates than traditional savings accounts. A 12-month CD at Marcus by Goldman Sachs, Member FDIC, earns Annual Percentage Yield (APY) as of May 23, 2023. Whereas a standard Advantage Savings account at Bank of America, Member FDIC, has an Annual Percentage Yield of .
• Low initial deposits. Some banks, such as Ally and Capital One, let you open a CD with any amount that works for you.

Depending on which financial institution you bank with, your bank or credit union’s CD products also might be referred to as:

• Term certificates
• Term CDs
• Savings certificates
• Time deposits

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CD Terms

The terms of a CD detail important information about the account. This includes the following features that are locked in:

• Interest rate
• Maturity date
• Principal
• Bank or credit union agreement

Types of CDs

There are some important distinctions between the different types of CD accounts. Understanding these differences can help you choose the one that’s best for you.

• No-penalty CD: No fee is charged for an early withdrawal but usually pays a lower interest rate.
• High-yield CD: Offers some of the highest interest rates available on the market, but usually with a longer term.
• Jumbo CD: Requires a larger investment — usually $100,000 minimum — but pays higher interest rates.
• Bump-up CD: Allows you to bump up to higher market interest rates if rates go up; usually, though, only one rate increase is allowed during the CD term.
• Step-up CD: Allows you to lock in your interest rate for a period, and your rate will increase over the term.
• Brokered CD: Offered by a stockbroker, online brokerage or other investment professionals, with a flat fee or percentage of the investment amount often charged.

Why Would You Use a CD?

People use CDs to help them meet a variety of financial goals. They include:

• Emergency funds
• Retirement investments
• Saving for a vacation or big-ticket item

CDs can be a part of anyone’s financial plans. They’re a great option for people who:

• Want a product that has a better interest rate than traditional savings accounts.
• Need liquidity but don’t want savings to be too accessible.
• Are saving for a special purpose such as a wedding or home improvement project.

Do CDs Affect Your Credit Score?

Assets such as savings accounts and CDs don’t directly affect your credit score. Your credit score is based on the following factors:

• How much money you owe.
• What types of credit you have.
• How often you pay your accounts on time.
• How long you’ve had your credit accounts.
• How many new credit inquiries you have.

Some banks check your credit when you open a new account. This can affect your credit score because it is a new inquiry. Fortunately, inquiries make up only 10% of your credit score, so a hard pull should drop your score by just a few points.

How To Open a Certificate of Deposit

Opening a certificate of deposit is similar to opening a checking or savings account. To open one you can follow these steps:

1. Choose a bank or credit union that offers certificates of deposit. You might qualify for relationship rates if you have a checking or savings account at the same institution.
2. Choose the type of CD you want. Compare the terms of the CD and interest rate.
3. Complete the application for opening a certificate of deposit. Many banks let you complete and submit this online.
4. Fund the account. You may be able to transfer money online or send a check.

Final Take: Is a CD Worth It?

Though CDs serve a purpose in financial planning, before opening a certificate of deposit, think about how it fits in with your financial goals. It’s a good place to keep money that you don’t need to access immediately since CDs typically earn more interest than savings accounts.

But pay attention to the term length. You may pay fees for cashing in the CD early. The interest rate might not keep up with the inflation rate. You can lose some purchasing power if you leave money too long in a CD with an interest rate lower than inflation.

Explore More on CD Accounts

• Certificate of Deposit (CD): What It Is and Whether It’s Right for You
• How To Open a CD Account in 4 Simple Steps
• How Much Money Should You Keep in a CD Account?
• What Is a CD Ladder? What You Need To Know
• Pros and Cons of CD Accounts
• Best CD Accounts

Caitlyn Moorhead contributed to the reporting for this article.

Rates are subject to change; unless otherwise noted, rates are updated periodically. All other information on accounts is accurate as of Jan. 31, 2023. 

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