A certificate of deposit (CD) is a type of savings account that lets you earn interest on your money over a fixed period of time. Unlike a regular savings account, where you can deposit and withdraw money freely, a CD has a set term — it could be as short as a week or as long as 10 years.
CDs usually pay a fixed interest rate, which means you know exactly how much you’ll earn by the end of the term. Because of this guaranteed return, CDs often offer higher interest rates than regular savings accounts, especially in certain market conditions.
How a Certificate of Deposit Works
When you open a CD, you agree to leave your money in the account for a specific period. For example, if you choose a 1-year CD, you commit to keeping your money in the account for one year. In return, the bank pays you interest, often at a higher rate than a standard savings account.
CDs are considered very safe because they are insured by the Federal Deposit Insurance Corporation (FDIC) up to the standard limits. This means that even if the bank were to fail, your money is protected.
Early Withdrawal Penalties
One important thing to remember about CDs is that your money is “locked in” for the term you choose. If you withdraw funds before the CD matures, you usually face a penalty. This penalty could reduce or even eliminate some of the interest you earned. Because of this, it’s important to choose a term that matches your financial goals.
Why People Use CDs
Many people use CDs as a safe way to grow their money without risk. They are especially useful if you don’t need immediate access to your funds and want a predictable return. CDs can also be a good tool for planning for future expenses, like a down payment on a house or a large purchase.
Example
Suppose you deposit $5,000 into a 2-year CD with a 4% annual interest rate. After two years, you’ll have earned $400 in interest, giving you a total of $5,400. If you try to withdraw the money after one year, you may lose part of the interest because of the early withdrawal penalty.
Overall, a certificate of deposit is a straightforward, low-risk way to save money and earn a guaranteed return. It’s ideal for people who want safety and predictability over quick access to their funds.
