by Elisabeth O'Quinn

The Simple Guide to a Certificate of Deposit (and Why You Need One)

Want your money to work harder? Consider a CD! What is a Certificate of Deposit, and how can you use it? Here’s a simple guide.
What is a Certificate of Deposit?

Certificate of deposit, or CD, is a term that strikes fear in the heart of new budgeters. We’ve heard it all: “But I can’t touch it for years, right?” “Don’t I need more money than I have to start one?” “I haven’t had a CD player since 2002.”

But we’ll tell you: CDs are pretty great savings vehicles if you want to get more bang for your buck. Leave your money in a CD with a bank for long enough and it could earn a larger return. Plus, the interest rate is guaranteed.

So what is a certificate of deposit? Keep reading to learn more.

Tip: We’ve put a glossary at the end of the article to help you better understand how a certificate of deposit works and what the lingo means.

What is a certificate of deposit?

A certificate of deposit is a sum of money you keep in a bank or credit union for a set period of time. That sum then generates interest. In short: give the bank some money for a while and you come out with more than your initial deposit at the end.

What is a Certificate of Deposit?

Image description: A blue bar graph showing the difference between savings account and CD rates. The left bar displays an average savings account yield of 0.09% APY. The right bar shows an average 12-month CD yield of 0.48% APY.

Rates are based on national industry averages pulled from this link here, are based upon the February 3, 2020 rates, and are for illustrative purposes only.

A CD is a different kind of savings vehicle, with some limitations:

  1. You generally can’t make additional deposits.
  2. You’re guaranteed an interest rate — one that generally doesn’t change — because you’re agreeing to hold your money at the bank for a specific period of time.
  3. You can’t withdraw the money (usually) without paying a fee.

And when you do withdraw the money from your CD (when it’s reached the period of time you agreed to hold it at the bank), you get your original deposit, plus the interest it earned.

Okay but, how does a certificate of deposit work?

Now that we’ve answered the question, “What is a certificate of deposit?” let’s dig into how these savings vehicles work. Remember, different CDs at different providers work differently. The information below is general and, when you’ve found the right provider, you’ll want to ask them for their specific certificate of deposit terms.

Where do I open a CD?

At a bank, credit union, or a financial services provider. They’ll hold your money for the period agreed upon, accruing interest all the while, until the CD reaches its maturity date.

How much interest will I get?

Rates vary. APY, or annual percentage yield, is the total amount your account will grow within a year (including compounding interest). The higher the APY, the better return you’ll receive on your money.

How long is my money locked up in the CD?

However long you agree to. It could be as short as seven days. It could be as long as five years. For example, there are short-term CDs that give your money back (plus interest) in less than one year, midrange CDs that give your money back in one to three years, and long-term CDs that give your money back five to ten years later. When selecting your CD term, remember that the higher the rate, the more interest you’ll accrue. You’ll want to balance how long you can keep that money separate with your savings goals.

If you’re not sure which to pick, think about what you want to do with your savings. A short-term CD is good if you’re just trying to avoid spending your savings. A long-term CD is good if you’re trying to save for a big purchase.

Just know that most CDs can be “unlocked” before the term is up if you agree to pay a fee. Be sure to ask about withdrawal penalties. And, as always, you should read the fine print. The point is to make money, not lose it. You’ll make the most of your savings if you allow your CD to fully mature, which means you retrieve your money only after the deadline has passed.

Some CDs are no-penalty CDs, which means no penalty for early withdrawal. We’ll talk about those later!

How much does it cost to buy a CD?

Banks usually require a principal — that’s what they call the amount of your deposit — between $200 and $10,000.

Are there different types of CDs?

There sure are. Until now, we’ve talked about traditional CDs, but there are others:

No-penalty CDs. While the interest rate for no-penalty CDs is often lower, you can take some or all of your money out early without paying a fee (although there can be limitations on when you can withdraw your funds). Traditionally with no-penalty CDs, you let your bank or credit union know in advance that you need to withdraw. Some institutions require a week’s notice, others a month or more. You can even choose a no-penalty CD from an online bank or financial services provider so you can manage your CD entirely online — no in-person visits required.

Learn more about no-penalty CDs.

Bump-up CDs. So far, we’ve highlighted the fact that CDs offer a steady interest rate over time, one that is not affected by the market. However, interest rates can climb. A bump-up CD allows you to take advantage of rising interest rates by “bumping up” the interest rate paid. But usually you can only do this once per term.

Jumbo CDs. Jumbo CDs typically require a deposit of at least $100,000.

Why should you open a CD?

A certificate of deposit is one tool that can help you if you have long-term financial goals that you want to achieve, such as buying a house or starting your own business. Putting your savings into CDs can help you reach those goals. You’re not only earning higher interest — typically more than a traditional savings account — but you’re also less likely to spend this money since it’s not easily reachable. Instead, you let it grow over a longer period. Out of sight, out of mind. This benefit helps outweigh the scariness of locking your money away.

Plus, as long as the bank you’re purchasing from is insured by the FDIC, your funds are covered up to the legal limit. You have the peace of mind that your savings are safe and sound and are earning a guaranteed interest rate. You also know exactly how much money you’ll have when the CD is fully grown, so you can plan for big purchases in advance.

Compare 3 types of interest-bearing accounts!

Strategies to leverage your CD deposit

CDs are a way to make the most of your savings because of their interest rate and low risk. But just because the account is static doesn’t mean your approach has to be. Here are a few ideas for how to use your certificate of deposit:

Start with short-term CDs

If you’re worried about tying up your money for a long time, start with a short-term CD. We recommend starting with a CD that lasts 12 months. If the first CD goes well, you could open another short-term CD or open one for a longer period. Or, you could ladder your CDs!

Create a CD ladder

If you want more flexibility and want to earn a little extra on your savings, building a CD ladder could be a good option. A CD ladder is created when you open multiple CD accounts at different interest rates and for different terms. In other words, instead of placing all of your savings in one CD or renewing the same CD each year, you place your savings in CDs with different maturity dates — this strategy can help you earn more interest and let you access some of your money every year.

For example, let’s say you have $5,000 in savings. You could open five CDs (aka five rungs on your CD ladder) all at the same time in 2020; each CD will then mature at intervals one year apart.

Amount Year APY
$1000 1-Year CD 0.48%
$1000 2-Year CD 0.63%
$1000 3-Year CD 0.75%
$1000 4-Year CD 0.81%
$1000 5-Year CD 0.95%

Rates are based on national industry averages pulled from this link here, are based upon the February 3, 2020 rates, and are for illustrative purposes only.

You’ll get your first $1,000 (plus interest) in 2021, your second in 2022, your third in 2023, etc. At the end of each year, you could put the money from your matured CD into a new 5-year CD, which, hopefully, gives you a higher interest rate. This strategy also ensures that the “top rung” of your ladder is always replaced.

What is a Certificate of Deposit? CD Ladders

Image description: A graphic showing how a CD ladder works. The timeframe of the ladder (today through Year 10) is shown at the bottom of the graphic. The top “rung” of the ladder shows a 1-year CD being invested in a 5-year CD after one year. Below this is a 2-year CD being invested in a 5-year CD after two years. These “rungs” continue through a 5-year CD being invested in another 5-year CD at the end of five years.

CD ladders are a great savings strategy because you have intermittent access to your cash while also earning interest on your savings.

Track your auto-renewal

Maybe you’ve placed $1,000 in a CD for one year. A year goes by, and you’re excited to get your money out. But when you look at your account, the CD has been renewed for another year. What happened? Auto-renewal.

Many CDs will automatically keep your money at the same interest rate unless you specify otherwise. This could be a problem if you wanted to use the money for something else or put it in a CD with a higher interest rate.

If you choose a CD that does auto-renew, keep a spreadsheet that tells you the date when you can get the money out of your CD(s). Also, set calendar reminders on your phone closer to the date to let you know that your CD is about to renew. If you don’t want to renew, plan to close the CD within the grace period (typically 10 days), so you don’t miss getting your money out.

You can also put your money in a CD that doesn’t automatically renew. Instead, when your CD matures, it’s closed and your savings are made available to you. You then don’t have to worry about keeping track of renewal dates (and losing the chance to access your savings).

Save for your long-term goals with a CD

Storing your money in a CD means that you need to have a little patience, but it is a good way to grow your money over time. And remember, CDs aren’t meant for immediate things, like an emergency fund or monthly expenses. Instead, they’re meant to help you achieve mid- to long-term financial goals, such as purchasing a vehicle or even college tuition.

So if you want a way to grow your money with a fixed interest rate, CDs are a great option. Learn more about Simple CDs here to get started.

Certificate of Deposit Glossary

Term: The length of time that you agree to store your money in a CD.

Interest rate: The amount of money that the bank agrees to pay you for storing your deposit with them.

Fixed or guaranteed interest rate: A fixed or guaranteed interest rate means that the rate stays the same throughout the CD’s term.

Compound interest: CDs earn compound interest, which essentially means that your interest is earning interest, on top of the principal balance.

APY: This acronym stands for annual percentage yield, and it’s basically the total gain your account will achieve within a year (including compounding interest), expressed as a percentage (e.g. 1.01% APY).

Maturity date: The date when you can get your money out of your CD. A mature CD means that you get your full principal balance and any interest.

Early withdrawal penalty: The amount that you agree to pay if you withdraw a portion or all of your deposit early (this doesn’t apply to no-penalty CDs).

Disclaimer: Hey! Welcome to our disclaimer. Here’s what you need to know to safely consume this blog post: We do our best to make sure information is accurate as of the date of publication, but things do change quickly sometimes. Any outbound links in this post will take you away from, to external sites in the wilds of the internet; neither Simple nor our partner bank, BBVA USA, endorse any linked-to websites; and we didn’t pay/barter with/bribe anyone to appear in this post. Individual situations will differ; consult your favorite finance, tax or legal professional for specific advice. And as much as we wish we could control the cost of things, any prices in this article are just estimates. Actual prices are up to retailers, manufacturers, and other people who’ve been granted magical powers over digits and dollar signs.

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