When and Why Should I Open a CD?

The years 2022 and 2023 were not the kindest to our wallets. But amid rising prices (i.e., inflation) there’s at least one perk: Savings account rates have increased, including on certificates of deposit.

Some CDs have returns upward of 5% right now, but like any bank account, they don’t work for every financial situation. Let’s see if CDs make sense for you.

Quick definition: CDs that hold money, not music

In banking, a CD refers to a certificate of deposit, which is a type of savings account with a fixed term and fixed interest rate. You add money, wait for the CD’s term — usually three months to five years — to end, and get your money back with interest.

The main places to open CDs are banks and credit unions, which are banks’ not-for-profit counterparts. Credit unions tend to call CDs “share certificates.” Brokerages also offer CDs, but the process is more complicated and requires an investment account.

CDs: The good, the bad, the penalty

The good

Here’s the biggest reason to consider CDs: They can offer the highest guaranteed returns for a bank account. And current CD rates are some of the highest in over a decade, based on NerdWallet data and analysis of Federal Reserve data. When the Fed raises its rate, as it did multiple times in 2022 and 2023, banks and credit unions usually raise their savings and CD yields. See where rates are headed in our CD rate forecast.

Hands down, the best rates are at online-only institutions where rates can be above 5% at the time of writing. The national average CD rates, in contrast, include 1.84% for one-year CDs and 1.35% for five-year CDs, still better than the national average of 0.43% on regular savings accounts.

Take this scenario: Put $10,000 into a CD at 5% APY for a five-year term, and you’ll earn around $2,763 in interest, rounded to the nearest dollar. Try that same amount and time frame but in a savings account with a 0.50% rate, and you'll earn about $253.

Unlike some checking or savings accounts, CDs don’t have monthly fees or minimum balance requirements other than a minimum amount to open. High-yield CDs have minimums that range from $0 to $10,000.

The bad

CDs are the bank account equivalent of a lockbox. In exchange for high rates, you give up access to funds. The first time you add money is nearly always the only time you add money, so you have to be OK with transferring a decent sum of cash into an account upfront. Then your money gets locked up for the CD term you choose.

The penalty

If you need to cash out a CD early, it might hurt. You must withdraw all the money in one transaction and almost always pay a penalty that can cost several months’ to a year’s worth of interest you earned — or would’ve earned. A bank can dip into your original amount to cover a penalty. Unlike other bank accounts, though, CDs only have this one potential cost, and you can avoid it by waiting for a CD to mature.

When would CDs work best for me?

CDs have more specific use cases than your everyday checking and savings accounts. Ask yourself any of these questions before deciding to open one.

1. Do I need more distance from some savings?

Say you come into an inheritance or other type of windfall, you’ve built up savings for years, or you put some savings in a share certificate to keep it out of reach (or your parents did that for you). Whatever the reason, a CD is built to keep you from being tempted to spend those funds.

2. Do I have savings earmarked for a big purchase?

If you have a sum intended for a car or down payment on a home in the next few years, a CD helps you set aside the funds until you’re ready.

3. Do I want to protect some wealth outside of investments?

CDs provide short-term safety, not long-term growth. Funds are federally insured just as they are in other bank accounts, meaning your funds get returned to you even if a bank goes bankrupt. CDs also don’t have the risk of fluctuation in value as in the stock market.

CDs “sit in the middle ground between emergency savings and investing,” says Derek Brainard, director of financial education at the AccessLex Institute, a financial literacy nonprofit. Essentially, CDs are cash reserves for short- to mid-term goals ranging from months to a few years down the road. Emergency savings should be immediately accessible if they’re needed, while investing — such as in stocks or bonds — is for accumulating wealth in the long term, Brainard explains.

Current high-yield CDs for terms of 12 to 18 months – with rates around 5% — “can certainly become a more attractive (and FDIC-insured) alternative to bonds for those seeking income or capital preservation in the short-term,” Brainard said in a later email.

What if CDs aren’t right for me?

Giving up the thought of high CD rates might be hard, but maybe you realize that losing access to funds isn’t worthwhile. You can still take advantage of the current rate environment by opening a high-yield savings account. Like high-yield CDs, these accounts are mostly available at online-only banks and credit unions. Many have rates close to 5% APY right now, and you can add or remove money at any time.

I want a CD, but what if CD rates change soon?

A CD’s fixed rate can be a double-edged sword: It provides guaranteed returns, but if rates rise, you lose out on higher rates after you lock in yours. And rates have been increasing lately.

“If you do believe the rising rate environment will continue, one strategy to offset that risk is certificate (or CD) laddering,” CJ Pointkowski, assistant vice president of savings products at Navy Federal Credit Union, said in an email. “If you feel we are near the end of the rising rate environment, it makes more sense to lock in funds for a longer term at the elevated rate,” he said.

Laddering CDs, or creating a CD ladder, involves opening multiple CDs of different terms — generally short, midrange and long terms. A common ladder consists of one- through five-year CDs where five CDs mature at staggered intervals, such as every year for the next half-decade. When each CD ends, you can reinvest in a new five-year CD to take advantage of higher future rates — or you can redeem the CD.

If juggling multiple CDs sounds like a hassle, another strategy is to open a no-penalty CD or a bump-up CD. These less-common types of CDs have more flexible features than regular CDs do.

• No-penalty CDs allow for a free early redemption at any point after the first few days, which removes any barrier of switching to a higher-rate CD or different type of investment later. 

• Bump-up CDs let you increase the rate at least once during a CD term, provided that rates on the banks’ new bump-up CDs have gone up. But rates alone shouldn’t guide your decision to open a CD.

"At the end of the day, a CD is either going to be the right tool or not, regardless of what’s happening in the interest rate environment,” Brainard says.