What is a CD? Certificate of deposit explained

Panna Kemenes
04.15.21
6 minute read

If you want to earn higher interest rates on your savings, you may want to consider certificates of deposit. These are savings accounts that offer a fixed interest rate and fixed savings term.

You can get the full benefit of a CD account by leaving funds investing for the full term. For those who can do this, a certificate of deposit can be a good savings option.

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📝 Table of contents

What is a CD, and how does it work?

What is a CD account?

A certificate of deposit (CD) is a type of savings account. It has a fixed interest rate that is usually higher than that offered by a regular savings account.

Funds in a certificate of deposit have to be left in the account for a fixed length of time to earn the full interest.

How does a certificate of deposit work?

CDs require a single initial payment rather than regular additional payments, as you may do with a savings account. The important point to remember is that any money put in must be left for a fixed period.

After the fixed length of time, typically anywhere between three months and five years, the interest payment will be added to the account. It can then be withdrawn to a different account or reinvested into another CD.

Most providers will automatically reinvest into another CD if you don't arrange otherwise.

CDs are designed to have the funds left in for the fixed period, and you should consider this before opening. Most will allow early access if you need the money back before the fixed term is up, but this will carry a penalty.

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Where can I open a CD?

Taking out a certificate of deposit is straightforward. It's just like opening a standard account with a bank or credit union and can be done online or in-branch depending on the company.

Many banks and credit unions offer CDs. They will offer different CD accounts, with varying interest rates, fixed periods, and withdrawal penalties.

Looking at different providers can pay off, as CD interest rates vary widely. To get the best rate or terms, you might need to look beyond your current bank.

Payments into a CD can be made from a different bank. Likewise, funds (or interest) can be transferred to another account after the fixed term.

The following are some main CD accounts compared:

BankTop account features
Ally Bank High Yield CD¹
    APY: 3-months 0.2%, 6-months 0.25%, 1-year 0.55%, 3-year 0.65%, 5-year 0.8%
    No minimum balance
Wells Fargo CD²
    APY: 3-months 6-months or 1-year 0.01% (0.02% if linked with other Wells Fargo accounts through a portfolio relationship)
    $2,500 minimum balance
Discover Bank CD³
    APY: 3-months 0.2%, 6-months 0.25%, 1-year 0.5%, 3-year 0.55%, 5-year 0.6%
    $2,500 minimum balance
Chase Bank CD⁴
    APY: 3-months 0.2%, 6-months, 1-year, 3-year or 5-year 0.02% to 0.05% depending on balance
    $1,000 minimum balance

Where can I open a CD

Are CDs safe?

CDs with banks are insured by the federal government through the Federal Deposit Insurance Corporation (FDIC)⁵.

This will cover you in full for any losses in the event of any bank failure or inability to repay funds. There is a limit of $250,000 per institution.

If you are investing more than this amount, you could split the investment between multiple institutions for additional cover.

If you take out a CD with a credit union, it will be insured to the same level through the National Credit Union Administration⁶.

Reasons to choose a CD account

The main reason to opt for a CD is the possibility of higher interest payments. If you are happy with the fixed term and other restrictions, then it makes sense to get a high return for your savings.

Pros and cons of a CD account

ProsCons
  • Higher interest rate (APY) than regular banking or savings accounts
  • Guaranteed interest rate (regular accounts can fluctuate)
  • Low-risk investment and federally insured
  • No penalty-free withdrawals from the account during the fixed term
  • Withdrawal penalties will harm returns if you do need to access money early
  • Requires upfront lump-sum payment and can't add further deposits

What CD term should I choose?

Most financial institutions will offer a range of different CD investment terms. This is usually between 3 months and 5 years (but some providers offer as low as 1 month and up to 10 years).

You should base the choice of term on your circumstances and saving goals. To get the full interest payment without penalty, you must leave the CD untouched for the full term.

Remember, you can always open a further CD after the first term is up. And you have a chance at that point to access the funds.

What is a CD ladder, and how to build one

The main drawback of CDs is having to leave your funds untouched for the full period. If you need access early, you'll lose out on the full interest payment.

One solution to this is to open multiple CDs with different fixed terms and reinvest these as they mature. This is known as a CD ladder.

This approach provides more flexibility, with the ability to access the funds at the end of each term. The split between different terms and amounts will depend on your circumstances.

For example, you could make a single $10,000 investment in a five-year CD. Or, using a ladder approach, you could split this into four $2,500 investments in a 6-month, 1-year, 3-year, and 5-year CD.

As each of these matures, you can then reinvest it into a long 5-year CD. This will continue to offer regular points when each CD matures, and you can access funds.

CD ladder

What to do when a CD matures

As long as you don't access the funds throughout the term, the CD will mature when the period is up.

Usually, you will receive a full interest payment upon maturity of the CD. Some providers will also allow a more regular payment of interest (such as quarterly or annually).

Interest will either be deposited into the CD or paid out to another account.

You then have a grace period before the funds are automatically reinvested into another CD. During this time, you have a chance to:

  • Make withdrawals from the account with no penalty (as long as the minimum balance is left in)
  • Add further funds to the account
  • Close the CD, or consider other provider options
  • Change the term for reinvesting

Make sure you stay aware of when your CD is maturing, so you can use this grace period.

Providers should notify you before maturity. Some providers will allow you to set up a transfer before the maturity date, which will then go through after maturity.

If you choose to allow the CD to be reinvested, this will be at the new interest rate the provider offers at the time. This could, of course, be higher or lower than your previous rate. This can be checked on the provider's website.

Some providers also offer a bonus when you choose to renew a CD with them.

Withdrawing money early from a CD

Most CDs will allow early withdrawal, but this will incur a penalty. This is usually applied as a loss of a certain amount of interest. It is usually a fixed penalty based on the term length of the CD.

As an example, the following penalties apply for the Ally Bank⁷ High Yield CD:

  • 60 days of interest for terms of 24 months or less
  • 90 days of interest for terms between 25 months and 26 months
  • 120 days of interest for terms between 27 months and 48 months
  • 150 days of interest for terms over 49 months

Some banks offer CDs with no penalties for early withdrawals. They will generally offer lower interest rates and are more comparable with savings accounts.

CD vs savings accounts

CDs are a type of savings account, but there are some key differences. Savings accounts are better when you need regular access to your money or prefer to save in installments.

CDs will usually offer a higher interest rate, but funds must be left deposited for a fixed term to maximize the return. You can only withdraw, penalty-free, during a short grace period after the CD matures.

You should compare both CDs and savings accounts. Market offerings change frequently, and there may, at times, be little difference between them.

Ultimately, the choice comes down to your assessment of how much extra interest a CD will pay versus its restrictions.

Manage multiple currencies with Wise

This discussion of CDs and savings accounts relates to US Dollar savings. If you have funds in different currencies or need to make international transfers in or out of your savings, consider a Wise multi-currency account.

A Wise account allows you to manage multiple currencies. You can convert currencies to USD at the mid-market rate (the one you see on Google), so none of your savings are wasted on hidden fees.

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Sources:

  1. Ally Bank High Yield CD
  2. Wells Fargo CD
  3. Discover Bank CD
  4. Chase Bank CD
  5. FDIC
  6. NCUA
  7. Ally Bank

All sources checked 14 April 2021


This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from TransferWise Limited or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date.

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