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If you’re looking for a safe way to grow your money, a certificate of deposit (CD) could be right for you.
A CD is a federally insured savings account with a fixed interest rate offered by most banks — but there’s a catch. If you open a CD account, you’re agreeing to leave your money alone for a specific number of months or years.
If you’re OK with that trade-off, opening a CD is a savvy way to put your savings to work and could align nicely with your financial goals. For example, you might want to save for a down payment five years from now, or may want to build your savings without exposing them to the stock market.
However you use it, a CD is a tool you can use to park your money and earn interest on it.
How We Calculate Your CD Earnings
By filling in some key pieces of information, our calculator tells you how much you can expect to earn on your CD investment and the total balance over time.
If you’re considering a CD or looking to better understand how they work, enter the initial deposit amount, length of CD term, and the APY rate into our calculator. Compare different CDs to help you choose one that best fits your needs before you open an account. You can play around with the numbers on the CD rate calculator to determine how much interest you can earn with different CDs and see how much to invest to reach your savings goal. Here are some important terms you should know when it comes to CDs:
Initial deposit amount
The amount you’ll deposit to initially open the CD. Some accounts require you to deposit a minimum amount.
Length of CD (months and years)
The amount of time you’ve agreed to leave your funds untouched in a CD account, or there’s an early withdrawal penalty. This is also known as the CD’s term.
The annual percentage yield (APY) is the rate of return you’ll earn annually and takes compounding into account.
A percentage of money that’s added on top of your principal investment over the course of the CD term.
Your initial deposit plus interest earned that is available for withdrawal at the end of your CD investment term.
How Do CD Rates Work?
CDs are considered low-risk investments, but it’s still beneficial to comparison shop to find the best CD rates.
CDs offer a fixed rate of return upon maturity. While online banks tend to have better CD rates — compared to legacy banks and credit unions — they aren’t as competitive as they once were, because of recently lowered interest rates.
For instance, the national rate for a traditional CD under $100,000 with a one-year term is less than 1%, according to the FDIC — a rate that’s topped by most high-yield savings accounts where you can withdraw your money whenever you want. Exact CD rates differ across financial institutions and can partly depend on the length of the term. There are also minimum deposit requirements for CD products, which vary from $0 to $1,000 or potentially more.
What Term Length Should You Get?
A CD comes with a time commitment, but you get to choose how long you want that to be. When you open a CD, there is a “term” attached to it; it’s how long you can leave your money in the CD. When the term ends, the CD reaches maturity and you can reaccess the funds.
Some terms might be shorter — only a few months or a year. Others can be longer, like two years, five years, or even 10 years. The most common CD lengths offered by banks are one-year, 18-month, two-year, three-year, four-year, and five-year terms.
The rule of thumb is the longer the CD term, the better the interest rate and yield, but right now, the difference in rates between short-term CDs and long-term CDs is less than a percentage point.
Whether you should invest your money in a short-term CD or a long-term CD ultimately depends on your savings goals. Ask yourself this question before choosing a CD term: how long am I able and willing to stash my money away?
A short-term CD might make more sense for you if you’re okay with lower rates and a lower level of commitment. For example, if you have some money you’d like to temporarily stash away to buy a car by the end of the year, you might put it in a short-term CD. When it’s time to pay for the car, you can easily take it out without incurring an early withdrawal penalty.
A long-term CD makes more sense if you want to save for something that will happen in a few years, such as a down payment on a house.
How Much Interest Will You Earn on a CD?
If you’re opening a CD account, you’re doing it to earn interest on savings that would otherwise be sitting in a normal checking or savings account. But the amount of interest you can earn on a CD depends on several factors.
The financial institution you open the CD account sets the amount of interest you can earn, which varies with every CD term. And then there’s the frequency of compounding to consider. Your money will grow faster over time if there’s more frequent compounding. CDs usually compound on a daily or monthly basis.
Roughly 20 years ago, you might have been able to find a five-year CD that yielded 6%. But if you were to open a CD right now, your interest rate would be really low, ranging between 0.25% and 0.9%.
What Happens if I Withdraw a CD Early?
Once you put money into a CD, you have to leave it there until the account matures. If you don’t, you could be charged an early withdrawal penalty.
It’s a fee for withdrawing from the account early, but there isn’t a standard early-withdrawal penalty fee across all financial institutions. It depends on your CD term and how soon you withdraw your money. Generally, the longer the CD term, the larger the penalty will be.
In most cases, you’ll get back your principal — but that’s it, which defeats the purpose of putting your money in a CD account. There are circumstances where an early withdrawal penalty can cost more than the interest you’ve earned, and you could lose some of your initial investment.
When Will CD Rates Go Up?
Interest rates are lower than ever, and that’s not changing anytime soon. CD rates are largely affected by the federal funds rate. The Federal Reserve slashed the federal funds rate in March 2020 in an attempt to keep the economy afloat during the coronavirus pandemic. The Fed has since said that it expects the federal funds rate to stay near zero until at least 2023 to help the economy recover.
How to Choose the Right CD for You
CDs generally earn higher interest rates than most savings and money market accounts, although that’s not the case right now with historically low interest rates meant to support an economy challenged by the COVID-19 pandemic.
So depending on your financial goals, you’ll need to weigh the pros and cons of a CD and figure out whether you want to open a short-term, mid-term, or long-term CD account. By picking the right CD term for you, you’ll also avoid any early withdrawal penalties. Once your CD reaches maturity, you can withdraw your initial deposit plus interest earned.
Alternatives to CDs
Because interest rates are so low, there are better options to get more out of your money at this time. Here are three to consider:
High-Yield Savings Account
There’s no point in having your money locked away in a CD for months if rates for many high-yield savings accounts are the same or better than current CD rates. With a high-yield savings account, your money is earning just as much interest as it would in a CD — but you have the luxury of being able to pull it out whenever you want. That gives you more flexibility to move your money into another type of account if rates rise or to other investments at any point.
Pay Off High-Interest Debt
If you have extra cash and a decent emergency fund, you can redirect your focus to paying down debt with high interest rates first, like credit cards or personal loans. Choose a debt payoff strategy, such as the avalanche or snowball method, and make a plan before you start.
Invest for the Long Term
If your goal is to save for the long term, investing in the stock market through a retirement account makes more sense than putting your money in a CD. For example, a 401(k) and Roth IRA can deliver better returns over longer spans of time — as much as 6% to 8%. If you don’t know how to get started, read our advice from Erin Lowry, a NextAdvisor contributor and author of the “Broke Millennial” book series, on building a “good enough” investment portfolio.