Interest Rates on CD Accounts Are Falling. Are They Still Worth It?

Photo illustration to accompany article on certificates of deposit (CDs) ©Getty Images

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Certificates of deposit, or CDs, operate on a basic tradeoff—in exchange for locking up your money for a fixed amount of time, you get a higher interest rate.

Following the Federal Reserve’s decision in early 2020 to reduce benchmark rates to near-zero in response to the coronavirus pandemic, that difference today is marginal—you may even find higher interest rates on regular savings accounts. But when the economy moves toward a higher-rate environment in the future, CDs can be an extremely lucrative way to earn added interest on your savings.

What Is a CD?

When you deposit money into a CD, you are effectively leaving your money there for a predetermined period of time, in exchange for a set interest rate. You can find CDs that range from just a few months to more than 10 years, so it’s important to ensure upfront that you won’t need access to the money before the end of your term. Withdrawing early can carry penalties. 

Like savings accounts, you can rest assured that your money is safe, no matter what happens to the markets or your financial institution. CDs worth up to $250,000 are federally insured at banks by the FDIC, and up to the same amount is insured by the NCUA if you open your CD with a credit union.

Here’s a more in-depth look at factors you should consider before opening a CD and how you can best use these products in your financial plan.

Why Choose a CD?

The primary reasons to stash your extra savings in a CD involve security and potential interest earnings.

Since CDs are less accessible than traditional savings accounts, you won’t run the risk of dipping into funds you’ve reserved for a specific purpose just because you need some extra cash. In that way, you’re securing your cash even from yourself. 

And because they’re federally insured similarly to other deposit accounts, as long as you keep your money in the account until the end of your term, you won’t lose any money on your deposit.

Another important distinction that sets traditional CDs apart from other savings vehicles is the fact that the interest rate you lock in at the beginning of your term remains the same regardless of what happens to interest rates in the interim. 

If you open a CD during a period of high interest, you can lock in a higher interest rate than you’ll be able to access when rates go down. Getting your timing right when it comes to interest rates can be a great way to help determine when locking up your money for a period of time is a good choice.

“People who locked in a three-year CD a year ago are very happy, because current rates are much lower,” says Mark Wilson, CFP, founder and president of MILE Wealth Management in Irvine, California. “If they locked it in at, say, 3%, that looks really good compared to what they could get today. There’s some times where locking it in benefits you.” 

Step Up Your Savings With CDs

If you’re just starting to save — maybe you’re building up an emergency fund or making contributions toward a down payment on a new home — a CD is probably not the best vehicle.

You’ll need a lump sum to deposit into your CD upfront, and you won’t have the option to contribute monthly or each pay period. In order to make automatic transfers or regular contributions, stick to a high-yield savings or money market account. 

Then, once your safety net is in place, consider using CDs to bolster your financial plan.

For example, if you’ve saved 12 months’ worth of expenses in an emergency fund, but you’re confident you’d feel comfortable with just six, consider moving the extra to a long-term CD with an interest rate boost. Or if you’re nearing retirement age and have some extra cash that you’d like to save for a down payment on a second home in five years, park it in a CD to ensure you won’t spend it or lose any of its value in a more volatile investment account.

Details to Consider When Choosing a CD

You’ll have limited access to funds in a CD, so you’ll want to be certain you’re choosing the right product before depositing a large sum of money into one for any time period. 

Here are a few things to research about any CD you choose:

Term

Because CD terms have a broad range and can affect your interest earned, your CD’s term is one of its most important characteristics. 

Determining the purpose of the money you’re putting into your CD can help inform what term lengths you should consider. If it doesn’t have any specific purpose, think through the length of time you’d be most comfortable not having access to those funds. Most importantly, be certain in whatever you decide.

“Maybe you want to buy a house in a year or two,” says Chantel Bonneau, CFP, wealth management advisor at Northwestern Mutual. “But when you buy a 10-year CD, you’re basically promising them that you’re not going to touch it. You want to look at the term and be very confident that you’re not going to want that money in the interim.”

Interest rate

With today’s climate leaving interest rates near-zero, the rate your money will earn in a CD is not much different from what you can find from many high-yield savings or money market accounts.

But in a higher rate environment, you’ll likely earn more in a CD than in a savings account. Still, if you’re looking for the highest rate of return, you won’t earn it through CDs. They may offer higher rates than other deposit accounts, but riskier investments in stocks and bonds will offer higher potential returns — but without the security.

And remember, terms and interest rates are closely tied when it comes to CDs, so you should be confident in both. “Typically, the longer the term, the more benefit you get from locking up your money,” Wilson says. “A three-month CD’s return is going to be lower than a three-year CD.”

Penalties

In a worst-case scenario, it is possible to access the money held in a CD before the term has reached maturity, but you’ll face a penalty for doing so.

Penalties vary depending on type of CD and institution, but may include all or some of the interest you’ve earned up to that point in the CD’s term or even a portion of your original deposit.

However, there are liquid options available through no-penalty CDs. You’ll still be able to lock in a fixed rate and may be able to make one-time or partial withdrawals, but you likely won’t earn as high a rate as a traditional CD.

Pros of CDs

  • Potentially higher interest rates than traditional savings or money market accounts.
  • Ability to lock in a higher interest rate during a falling rate environment.
  • Safety and security of your deposit. You won’t have to worry about market volatility, and deposits are FDIC-insured.

Cons of CDs

  • In a low interest rate environment, the margins between CD interest and traditional savings are not high.
  • You lose access to your money for the full term of the CD, or face a penalty for withdrawal.
  • You cannot make regular contributions to build up savings, and instead must deposit a lump sum at the start of your CD’s term.
  • Know what type of CD you’re considering. Some types carry more risk than traditional CDs.
  • Your interest earnings are taxable income (this is true for any deposit account).

In a Low Interest Rate Environment, Is a CD Worth It?

When interest rates are high, CDs can provide highly competitive rates on even relatively short term products. In today’s environment, though, many CD interest rates are comparable to, if not lower than, rates on more liquid savings and money market accounts.

And while higher rate environments may offer incentive to lock up money in a long-term CD for even more interest, those margins aren’t as lucrative today either. For many people, the small difference in interest likely won’t justify losing the cash flow.

“I don’t think you’ll be penalized by waiting or having a bit more liquidity,” Wilson says. “The differences are very small today, and that’s just because the yield curve is flat. But there are times when it’s very steep and going from one year to three years to five years to 10 years could be a really big difference in the yield.”

Bonneau recommends crunching numbers to get a better sense of the value proposition. If you have $20,000 that you don’t need to access for 10 years, for example, the 1.5% you’ll earn by putting it in a CD will be about $300.

“You need to always be evaluating that trade-off,” Bonneau says. If that amount of money earned means a lot to you, you may weigh it heavily. 

“If it doesn’t mean that much, then maybe it’s not worth locking it up,” she says. “The weight of that decision means different things to different people based on their circumstances. Sometimes people get wrapped up in the 1% but they forget what that actually means in dollars.”