Sun Valley Jose Mier helps you make your money work harder for you. Certificates of deposit, commonly called CDs, are one of the simplest ways for savers to earn interest on money they do not expect to need immediately. A CD is essentially an agreement between you and a financial institution: you deposit a specified amount of money for a predetermined period, and in return, the institution pays you interest. At the end of the term, the CD reaches maturity and you can generally withdraw your original deposit plus the interest earned or, in many cases, renew the money into another CD.
While CDs are straightforward, shopping for one can be surprisingly complicated. Interest rates can differ substantially from one financial institution to another, even when the CDs have identical terms. A six-month CD at one bank might pay considerably more or less than a six-month CD at another institution. Credit unions can also offer rates that differ from those available at traditional banks. Understanding why those differences exist can help savers make better decisions about where to put their money.
How a Certificate of Deposit Works
A CD differs from an ordinary checking or savings account because the money is generally committed for a specific period. Common CD terms include three months, six months, one year, 18 months, two years, three years, and five years, although financial institutions offer many variations.
Suppose you deposit $10,000 into a one-year CD paying a 4% annual percentage yield. Assuming the advertised APY and compounding structure remain as stated, you would earn approximately $400 over the year. At maturity, you would have your original $10,000 plus the interest.
The actual amount earned depends on the CD’s APY, the balance, the term, and the institution’s compounding policies. That’s why it is useful to compare APYs rather than simply comparing nominal interest rates.
The major trade-off is access to your money. A conventional CD is designed for money that you can leave untouched until maturity. If you withdraw the funds early, the bank or credit union may impose an early-withdrawal penalty. Depending on the account, that penalty could consume some or all of the interest you earned and, in certain circumstances, potentially affect your principal.
For that reason, money needed for an emergency fund or an upcoming major expense generally belongs in a more accessible account rather than a conventional CD.
Why Do CD Rates Differ?
One of the first things people notice when shopping for CDs is that rates can vary dramatically.
There isn’t one universal CD rate. Each bank and credit union establishes its own deposit rates based on factors such as its funding needs, competition, operating costs, loan demand, and expectations about interest rates.
Banks use deposits to help fund their lending activities and other operations. A bank that needs additional deposits may offer particularly attractive CD rates to encourage customers to bring money to the institution.
Competition also plays a major role. If several banks in a market are aggressively competing for deposits, they may increase their CD rates. Conversely, a large bank with an enormous existing customer base may have less incentive to offer the highest rate in the market.
This is one reason consumers should not assume that their current bank automatically has the best CD available.
Traditional Banks and Their CD Rates
Traditional banks remain one of the most familiar places to purchase a CD. These institutions may have extensive branch networks, established online banking systems, ATMs, and a broad selection of financial products.
The convenience can be valuable, especially for customers who prefer having a physical branch nearby.
However, convenience does not necessarily mean the highest interest rate.
Large national banks sometimes offer relatively modest rates on standard CDs, particularly on shorter-term products. They may have millions of existing customers and considerable amounts of deposits already on hand. Consequently, they may not need to offer exceptionally high rates to attract additional deposits.
That does not mean every traditional bank offers poor CD rates. Banks frequently introduce special promotional CDs, sometimes called “specials” or “relationship CDs,” that offer substantially better rates than their standard products.
The lesson is to compare the specific CD rather than judging an institution solely by its size.
Credit Unions and Certificates of Deposit
Credit unions are another important source of CDs. Technically, many credit unions refer to their certificates as share certificates rather than CDs because members purchase shares in the credit union. From a consumer’s perspective, however, the basic concept is similar: money is deposited for a specified term in exchange for a stated return.
Credit unions are member-owned financial cooperatives rather than conventional shareholder-owned banks. They typically operate on a not-for-profit basis, with earnings used to support the organization and provide benefits to members.
One potential benefit is that credit unions may offer competitive deposit rates, including on certificates.
Because their organizational structure differs from that of traditional banks, credit unions sometimes have the ability and incentive to return more value to members through competitive deposit yields and lower fees. A credit union seeking deposits to support lending can also compete aggressively for members’ savings.
But “credit unions always pay more” is not a rule. Some banks offer excellent CD rates, while some credit unions offer mediocre ones. Rates can change, and the best institution for one term may not be the best institution for another.
The Importance of Comparing APYs
When comparing CDs, pay close attention to the annual percentage yield, or APY.
The APY incorporates the effect of compounding and provides a more useful basis for comparing deposit products than the stated interest rate alone.
For example, imagine two one-year CDs:
- CD A advertises a 4.00% APY.
- CD B advertises a 4.50% APY.
If you deposit $20,000, the difference in the annual return is roughly $100, assuming the terms and compounding structure make the APYs directly comparable.
That may not seem enormous, but the difference becomes increasingly important with larger balances or longer periods.
Someone depositing $100,000 could see approximately $500 more in interest over a year from a 0.50-percentage-point APY difference, assuming the same basic conditions.
This is why shopping around can be worthwhile.
Don’t Forget About FDIC and NCUA Insurance
Safety is another major consideration when comparing banks and credit unions.
Deposits at FDIC-insured banks are generally insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. Federally insured credit unions generally have comparable federal deposit protection through the National Credit Union Administration (NCUA).
The insurance limits and ownership rules can be important, particularly for people with substantial savings. Before opening a CD, verify that the institution is federally insured and understand how the applicable insurance limits work for your particular ownership structure.
Deposit insurance is fundamentally different from investing in stocks, bonds, or mutual funds. A federally insured CD is a deposit product, subject to the applicable insurance rules and limits.
Of course, federal insurance does not mean every investment product sold by a financial institution is insured. Always confirm exactly what you are purchasing.
Short-Term Versus Long-Term CDs
Another consideration is the length of the CD.
Short-term CDs may be attractive when you want to keep your money relatively accessible or believe interest rates may rise. If you lock money into a five-year CD and rates subsequently increase substantially, you could be stuck earning the lower rate unless you pay an early-withdrawal penalty.
Longer-term CDs, on the other hand, can make sense when you want to lock in a competitive rate for an extended period and value predictability.
The best term depends on your financial situation and expectations. There is no universal “best” CD maturity.
Some savers address this uncertainty with a CD ladder.
What Is a CD Ladder?
A CD ladder involves dividing your money among CDs with different maturity dates.
For example, instead of putting $50,000 into a single five-year CD, a saver might divide the money among five CDs with different maturity dates. As each certificate matures, the funds can be reinvested or used for other purposes.
The advantage is flexibility. Rather than having every dollar locked away for the same period, some portion of the money becomes available periodically.
CD ladders can also reduce the risk of committing all your money to one interest-rate environment. If rates rise, you have money becoming available for reinvestment at the new rates. If rates fall, some of your money may remain locked into older certificates with higher yields.
Online Banks Can Change the Equation
When comparing traditional banks and credit unions, it is also worth considering online banks.
Online banks generally have fewer physical branches and may have lower overhead expenses than traditional brick-and-mortar institutions. Some pass part of those savings along to customers through competitive deposit rates.
As a result, the highest CD rate available to you might come from an online bank rather than either your local bank or a credit union.
Of course, the highest rate isn’t the only factor. Consider customer service, account access, minimum deposits, early-withdrawal penalties, insurance coverage, and how easy it is to move money when the CD matures.
A difference of a few basis points isn’t necessarily worth giving up features that are important to you.
Watch the Fine Print
A CD with an attractive advertised rate can come with conditions.
Some certificates require a substantial minimum deposit. Others may have unusual maturity periods or early-withdrawal penalties. Promotional CDs may be available only for new money or new customers.
Another issue is automatic renewal.
Many CDs automatically renew into a new certificate if you don’t provide instructions during a specified period around maturity. The new CD may carry a completely different interest rate from the original one.
Consequently, keep track of your maturity dates.
If your one-year CD matures on July 15, for example, don’t wait until August to discover that the money automatically rolled into another certificate with a less attractive rate.
When a CD Makes Sense
CDs can be particularly useful for money with a known purpose and timeline.
Perhaps you have $25,000 that you don’t need for the next year. Perhaps you’re saving for a future purchase, building a conservative portion of a larger financial plan, or simply want to earn interest without exposing the money to stock-market volatility.
A CD may provide a reasonable combination of predictable returns and principal protection, subject to applicable deposit insurance limits.
The key is liquidity. If you might need the money tomorrow, locking it into a CD may be inconvenient.
Shopping for the Best Rate
The simplest way to find a competitive CD is to shop around.
Check your existing bank, local banks, credit unions, and online banks. Compare CDs with the same maturity period and look at the APY rather than simply the advertised interest rate.
For example, compare one-year CDs with other one-year CDs rather than comparing a six-month promotional certificate with a five-year certificate.
Also check whether the institution is federally insured, what the minimum deposit is, and what the early-withdrawal penalty will be.
If a credit union offers a substantially higher APY than your bank, don’t automatically assume there is a catch. Credit unions frequently compete for members’ deposits and can offer attractive certificate rates. But don’t assume the credit union is automatically the winner, either. The best rate may be elsewhere.
Final Thoughts
Certificates of deposit remain a straightforward savings tool for people who want predictable returns and can afford to leave their money deposited for a specified period. Traditional banks, credit unions, and online banks all compete for depositors, and their CD rates can vary considerably.
Credit unions are particularly worth investigating because their member-owned structure can sometimes translate into highly competitive certificate rates. Traditional banks, meanwhile, may offer promotional products or other advantages that make them attractive despite not always having the highest standard rate.
Ultimately, the smart approach is to shop around. Compare APYs, terms, minimum deposits, early-withdrawal penalties, renewal provisions, and federal insurance coverage. A little research before opening a CD can make a meaningful difference in how much your savings earns.
And remember that the difference between a good CD and a great CD isn’t necessarily found in a complicated financial strategy. Sometimes it is simply a matter of asking one more bank—or one more credit union—what it will pay you to leave your money alone for a while.