What Is a Certificate of Deposit (CD) and How Does It Work?

When interest rates trend upward, you may want to earn a higher return on your savings. You could park your cash in a checking or savings account, but another option is a certificate of deposit (CD)—a type of savings account that generally offers higher yields than traditional savings accounts in exchange for agreeing to deposit your money for a specific time.

But what is a CD account? How do CDs work? And what are the pros and cons of opening a CD? Here's a primer on CD accounts, including how to invest in CDs and how CD interest rates work.

What Is a Certificate of Deposit?

A certificate of deposit is a type of savings account that generally offers a higher interest rate compared to standard or traditional savings accounts, but locks in your money for a fixed time. With FDIC insurance similar to other bank accounts, the funds are extremely safe, and eligible balances are guaranteed by the U.S. government.

CDs are considered one of the most stable and predictable ways to grow assets you don't need to access for months or even years. That's because the interest rate is fixed—meaning it won't fluctuate during the CD's term. When you open a CD account, your return is guaranteed.

Certificate of deposit accounts are somewhat flexible. You determine how much you want to deposit (within the bank's minimum deposit guidelines), as well as the maturity date that works for you (among periods offered by your bank). However, if you need to withdraw before the CD matures, the bank typically charges an early withdrawal penalty. So you won't collect all the interest you had expected and you may have to give up some principal, depending on your CD terms and how soon you make the withdrawal.

Key takeaway: CDs lock in a fixed interest rate with a set maturity date and feature predictable returns, often with higher interest rates than regular savings accounts. CDs can be a smart way to save for specific savings goals.

How Does a Certificate of Deposit Work?

If you're considering a CD for your finances, it's important to understand the basic features. Here's a closer look at how a certificate of deposit works.

CD interest rates and APY

When shopping for a CD, it's important to look for a term and interest rate that suits your financial circumstances and goals. Banks offer CDs with varying interest rates. In most cases, the longer the term of the CD, the higher the yield you'll receive. The interest rate and total payout typically make long-term CDs much more lucrative for savers than CDs with shorter terms.

For example, let's assume you deposit $5,000 in a one-year CD with a 2.8% interest rate. At maturity, you would earn $140 in interest—getting a total of $5,140 back. However, if you opt for a five-year CD at the same interest rate, you'll eventually get back $5,740, thanks to the longer term and the power of compound interest.

Balance	One-year CD	Five-year CD
Opening	$5,000	$5,000
Maturity	$5,140	$5,740

How much interest you accrue depends on the annual percentage yield (APY), which is how much interest you would earn with a savings account (like a CD) in a year. The APY hinges on two main things: the interest rate and how frequently the interest compounds. A higher interest rate and more frequent compounding lead to more interest earnings over the same period.

You can try our interactive CD calculator and compare rates to understand how much interest you might earn.

Fixed rates, fixed terms and maturity dates

To open an account, you'll typically need to deposit a lump sum into the account for a fixed term (e.g., 3 months to 5 years) and agree to leave the funds untouched until the term ends (the “maturity date"). CDs offer a fixed rate, so from the moment you park your money into the account, you'll earn interest on that lump sum deposit (also known as the principal).

Because interest rates are locked in for the duration of the CD, you can lock in above-market interest rates when interest rates are on the decline or get stuck with a below-average rate if interest rates increase.

Minimum required deposits

CDs usually have a minimum required deposit or minimum balance to open, though that's not a universal rule. Some financial institutions (like Synchrony Bank) don't require a minimum deposit for CDs, which gives you more flexibility in divvying up your savings. Typically, you need to fund your account within a certain number of days after opening.

Maturity dates

As the CD reaches its maturity date, it's important to pay attention to your updated options. Most CDs automatically renew, locking in your money for a new fixed term at the current interest rate without any action required from you.

For example, let's say you add some funds to a six-month CD. Once it matures, it automatically rolls the ending balance into a new six-month term. Your CD would renew at the current prevailing interest rate, which could be higher or lower than what you held before.

You can also opt out of renewing, and choose to cash out at maturity instead. In that case, you'll receive a payout for your CD balance, including the interest earned along the way.

[H3] Grace periods

Many CDs offer a grace period after they mature, which is a short window of time where you can take the money out of your CD and place it into another account without penalties. Or you could simply close the CD account and move your dollars into a checking or savings account.

However, the CD will automatically renew if you take no action during the grace period. You'll want to check the fine print of how your bank handles grace periods when opening a CD account. Synchrony Bank CDs feature a 10-day grace period.

How Are CD Rates Determined?

CD rates are determined by a few important factors, such as:

• • Market interest rates. Financial institutions generally look to the U.S. Federal Reserve's market interest rate, called the Federal Funds Rate, to set interest rates. If the Fed, as the bank is often called, raises interest rates, the interest rates of bank accounts, loans and credit cards typically follow suit. If the Fed Funds Rate falls, the rates on those accounts also generally fall.
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• • The financial institution. Online banks (like Synchrony Bank) usually offer more competitive CD rates than traditional banks with brick-and-mortar locations.¹
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• • CD term and features. In most cases, longer CD terms lead to higher interest rates. But you'll likely find exceptions for certain terms, depending on expected market conditions.

You can find our latest CD interest rates here.

Pros and Cons of CD Accounts

Before jumping into a new CD account for the first time, it's important to understand the advantages and drawbacks:

Benefits of CD accounts

• • Safe. A CD is one of the safest savings vehicles you can choose. Unlike the stock market or a variable-rate savings account, the interest rate on a CD is fixed and guaranteed, so you can grow your savings risk-free. Like other deposit accounts, each CD account is insured by the FDIC (as long as your bank is an FDIC member).
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• • Predictable. Because CDs have fixed and guaranteed interest rates, you can calculate exactly how much you'll earn in interest for the duration of the CD. CD terms typically span anywhere from three months to five years—it's your choice.
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• • Competitive interest rate. CDs usually feature higher interest rates compared to other FDIC-backed products, such as savings, checking and money market accounts.
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• • Different types of CDs. You can choose which type of CD you prefer. Some banks offer specialty CDs, which we'll get into later.

Cons of CD accounts

• • Early withdrawals can mean penalties. You'll get the most bang for your buck if you stick with your CD until it matures. Otherwise, an early withdrawal often means getting hit with a penalty. For instance, cashing out a one-year CD might mean paying 90 days of interest. A longer-term CD might have an even heftier penalty.
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• • You might miss out on higher earnings. If you have too much money tied up in a single CD, you might miss out on other financial products and accounts that offer higher rates. One solution is to tap into a bump-up CD—a savings product that allows CD holders to request that their current fixed interest rate be “bumped up" to a prevailing interest rate.
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• • They're not designed for certain financial goals: While CDs offer competitive interest rates, they're typically not sufficient to achieve long-term goals like saving for retirement. They're also not the best place to park your emergency fund, as you may need to suddenly tap into those dollars to cover unexpected costs.

5 Types of Specialty CD Accounts

With CD accounts, you've got choices! Choosing a CD depends on your financial goals and needs. Questions to ask yourself include when you need to access the money and how much you'd like to earn by depositing it into a CD.

1. Jumbo CDs

You'll need a significantly higher minimum deposit—such as $100,000—to open a jumbo CD. In return, the interest rates tend to be a lot higher. Of course, the trade-off is that you're promising to lock in a sizeable chunk of money. Besides having the funds to open a jumbo CD, you'll want to make sure you can commit to the CD term. Otherwise, you'll be dinged with an early withdrawal penalty.

2. Add-on CDs

An add-on CD allows you to add more funds throughout your CD. This way, you can earn more in interest over the duration of your CD term than if you had just deposited a single lump sum up front.

3. IRA CDs

An IRA CD is essentially an individual retirement account that houses certificates of deposit. These can be either a traditional or Roth IRA. And like IRAs, an IRA CD offers tax advantages.

4. Bump-up CDs

A bump-up CD is a product that allows a CD holder to request that their current interest rate be “bumped up" to a new rate the bank is offering for CDs. With Synchrony Bank's bump-up CD, you can boost your interest rate once during the term and take advantage of a higher return, giving you the ultimate flexibility. However, "bumping" is only available if the rate offered for the product rises during the term.

5. No-penalty CDs

No-penalty CDs allow you to withdraw funds before maturity without penalties. After a waiting period, you can withdraw the entire balance at any time without giving up interest.

How to Open a CD Account

A CD can be opened at any bank, credit union or financial institution that offers it. With Synchrony Bank, you can open a CD online in mere minutes. Most financial institutions, including Synchrony Bank, require the following information to open a new account:

• • Your name
• • Address
• • Social Security number
• • Copy of a government-issued ID (like a driver's license)
• • Checking account information to set up the initial deposit

You may also be asked for information about your background, such as your current and past employment, and debt.

If you're already a Synchrony Bank customer:

Sign into your account and follow the links to open a new CD account. Once you set up a new CD account online, which is easy to do, you can fund your new CD from either an existing Synchrony Bank account or connect to a non-Synchrony Bank account.

If you're transferring money from a non-Synchrony Bank account, you can do so via a paper check or ACH from your external bank account.

Common Questions About CD Accounts

When will CD rates go up?

Without a crystal ball, it's impossible to tell. However, interest rates generally increase during periods of inflation. So while you might feel a financial squeeze from the increasing cost of consumer goods, you also may see a rise in CD rates. A CD ladder can help you capture current rates without locking away all your funds for a long time.

Can you write checks from a CD?

You can't write a check drawing on a CD account. The money you deposit in a CD isn't accessible until it reaches its maturity date. So you can't withdraw funds by writing checks for funds sitting in a certificate of deposit.

Is a certificate of deposit liquid?

Certificates of deposit are considered slightly illiquid. While you can pull funds out, expect a penalty for early withdrawals. Be sure you don't need funds deposited into a CD until after the maturity date and you're comfortable without the cash for the entire duration. It's also a good idea to set funds aside in a separate savings account that you can pull from if needed.

How long does a certificate of deposit last?

A certificate of deposit lasts until the maturity date you choose when opening a new account. The maturity date is usually anywhere from three months to five years. You may find shorter terms or longer terms, however.

Final Say: Are Certificates of Deposit Worth It?

Putting your money into a CD might be worth the commitment if you have a stash of cash that you don't anticipate needing right away. That way, you can earn higher-than-average interest without any risks.

However, CDs aren't ideal if you might need to tap into that chunk of change sooner than the maturity date. For instance, any cash you need for an emergency or debt payoff may be better suited to a high yield savings account. CDs aren't ideal for very long-term goals such as retirement savings, either. Check out Synchrony's CD offerings to learn more and find out if one may fit your needs.

 

Eric Rosenberg is a financial writer, speaker and consultant based in Ventura, California. He is an expert in banking, credit cards, investing, cryptocurrency, insurance, real estate, business finance and financial fraud and security. His work has appeared in many online publications, including Time, USA Today, Forbes, Business Insider, NerdWallet, Investopedia and U.S. News & World Report. Connect with him and learn more at EricRosenberg.com.

 

LEARN MORE: See today's rates for a Synchrony Bank CD.

 

Sources/references

1. Neil Weinberg. Online Banks Are Passing on Higher Rates Faster. Chicago Booth Review. October 23, 2023.