Skip to main content

What is a CD and how do they work?

A certificate of deposit (CD) is a low-risk savings tool that can boost the amount you earn in interest while keeping your money invested in a relatively safe way.

Like savings accounts, CDs are considered low risk because they are FDIC-insured up to $250,000. However, CDs generally allow your savings to grow at a faster rate than they would in a savings account.

How CDs work

In exchange for depositing your money into a bank for a fixed period (usually called the term or duration), the bank pays a fixed interest rate that’s typically higher than the rates offered on savings accounts. When the term is up (or when the CD matures), you get back the money you deposited (the principal) plus any interest that has accrued.

If you need to access your funds before the CD’s term ends, you are subject to an early withdrawal penalty, which can significantly reduce the interest you earned on the CD.

Tip: Before opening a CD, make sure you have an emergency fund—a comfortable amount of savings in an easily accessible account, such as a savings account.

How terms, minimum balances and rates interact

CDs come in varying terms and may require different minimum balances. The rate you earn typically varies by the term and how much money is in the account. In general, banks offer a variety of terms and rates. It is important for you to review these rates and terms with each new CD and renewal to pick the product that best fits your current needs.

Compounding interest: Interest Rate vs. APY

Like savings accounts, CDs earn compound interest—meaning that periodically, the interest you earn is added to your principal. Then that new total amount earns interest of its own, and so on.

Because of the compound interest, it is important to understand the difference between interest rate and annual percentage yield (APY). The interest rate represents the fixed interest rate you receive, while APY refers to the amount you earn in one year, taking compound interest into account.

Choosing a CD

There are a number of factors to consider when choosing a CD. First, when do you need the money? If you need it soon, consider a CD with a shorter term. But if you’re saving for something five years down the line, a CD with a longer term and higher rate may be more beneficial.

Also, consider the economic environment. If it seems that interest rates may rise, or if you want to open multiple CDs, CD laddering can be a good option.

Building a CD ladder

Overall interest rates may change during your CD’s term. However, if rates go down, you benefit: You still earn the higher rate that was offered when you opened the CD. CD laddering, buying multiple CDs of varying term lengths, can help address this concern.

It can also be a way for you to take advantage of longer terms (and therefore higher interest rates) while still giving you access to some of your money each year.

With a CD ladder, you divide your initial investment into equal parts and invest each portion in a CD that matures every year. For example, say Leo has $10,000. To build a CD ladder, he invests $2,000 each in a 1-year, 2-year, 3-year, 4-year and 5-year CD. As each CD matures, he reinvests the money at the current interest rate or uses the cash for another purpose. If Leo reinvests his money, he might choose a new 5-year CD, which would ensure he has one CD maturing each year as long as he continues laddering.

Close text version

($10,000 to invest

$2,000 1 YR CD

$2,000 2 YRS CD

$2,000 3 YRS CD

$2,000 4 YRS CD

$2,000 5 YRS CD

at maturity, reinvest $2k + interests


Combining CDs with other accounts

Be sure to consider other options for saving or investing your funds. Different accounts offer different levels of risk and return. (Read more about how CDs compare with other low-risk savings accounts.) Always choose accounts that best fit your financial goals and your time frames. Learn more about CDs at Bank of America.

Close Disclaimer

The material provided on this website is for informational use only and is not intended for financial or investment advice. Bank of America Corporation and/or its affiliates assume no liability for any loss or damage resulting from one’s reliance on the material provided. Please also note that such material is not updated regularly and that some of the information may not therefore be current. Consult with your own financial professional when making decisions regarding your financial or investment management. ©2024 Bank of America Corporation.

Up Next

Contact Us