What happens when you open a CD

When you open a certificate of deposit, you give a bank or credit union a lump sum of money and agree to leave it untouched for a set period—called the term. In exchange, the bank pays you a fixed interest rate, usually higher than what a savings account offers. At the end of the term, you get your original money back plus the interest earned.

The bank uses your money during that time. That is why they pay you more than they would for a regular savings account where you can withdraw whenever you want. You are trading access to your cash for a better rate.

CDs come in different term lengths. Common options are 3 months, 6 months, 1 year, 2 years, 3 years, and 5 years. Some banks offer terms as short as 1 month or as long as 10 years. The longer the term, the higher the interest rate is usually—though not always, depending on what the bank decides and what interest rates are doing in the broader economy.

Key Takeaways

  • You deposit a fixed amount of money for a set term (3 months to 5 years are most common), and the bank pays you a may provide interest rate that does not change.
  • If you withdraw money before the term ends, you pay an early withdrawal penalty, which is usually a certain number of months' worth of interest.
  • Your money is insured up to $250,000 per depositor per bank through the FDIC (or NCUA at credit unions), so your principal is protected even if the bank fails.
  • Interest rates on CDs are fixed when you open the account, so you know exactly how much you will earn regardless of what happens to market rates later.
  • When your CD matures, the bank either returns your money or automatically rolls it into a new CD at the current rate, depending on your instructions.

How interest accrues and compounds

The interest rate on your CD is expressed as an annual percentage yield, or APY. This rate is locked in the day you open the account and does not change, even if the bank raises or lowers rates for new CDs the next week.

Interest compounds, meaning you earn interest on your interest. How often it compounds—daily, monthly, quarterly, or annually—varies by bank. Daily compounding is most common and works in your favor because interest gets added to your balance more frequently, and then you earn interest on that new balance. Over a year or longer, this compounds into noticeably more money than simple interest would.

You can calculate roughly how much you will earn by multiplying your deposit by the APY and the number of years. A $10,000 CD at 4.5% APY for 1 year earns about $450 (before accounting for the exact compounding schedule). The bank will show you the exact amount you will receive at maturity before you open the account.

Early withdrawal penalties and what they cost

If you need your money before the term ends, you can withdraw it—but the bank will charge an early withdrawal penalty. This penalty is usually expressed as a number of months of interest. A common penalty is 3 months of interest, meaning if your CD would have earned $450 over the year, the penalty is roughly $112.50.

The penalty comes out of your interest earnings first. If you withdraw early enough that you have not earned enough interest to cover the penalty, the bank takes the difference from your principal. This means you could get back less money than you deposited, which is why early withdrawal is costly.

Some banks offer no-penalty CDs that let you withdraw without a penalty, but these come with a lower interest rate to compensate the bank for that flexibility. Whether a no-penalty CD makes sense depends on whether you think you might need the money and how much the rate difference is.

What happens when your CD reaches maturity

When your term ends, your CD matures. At that point, the bank sends you a notice—usually 7 to 10 days before maturity—telling you what will happen next. You have options: withdraw the money, open a new CD, or move it to a savings account.

If you do nothing, most banks automatically renew your CD into a new one at the current interest rate for the same term length. This renewal rate is whatever the bank is offering on new CDs at that moment, not the rate you had before. If rates have dropped, your new rate will be lower. If rates have risen, your new rate will be higher.

To avoid an automatic renewal you do not want, contact your bank before the maturity date and tell them what you prefer. You can usually do this online, by phone, or in person. Some banks let you set your preference when you open the CD.

FDIC insurance and what it protects

Money in a CD at an FDIC-insured bank is protected up to $250,000 per depositor per bank. This means if the bank fails, the federal government guarantees you will get your money back, up to that limit. Credit unions are covered by the NCUA with the same $250,000 limit.

The insurance covers your principal plus any interest earned up to the maturity date. If your CD has not matured yet when the bank fails, you still get paid as if it had. You do not lose money because the bank went under.

If you have more than $250,000 to deposit, you can spread it across multiple banks or use different account ownership categories (like individual, joint, or retirement accounts) to stay within the insurance limit at each institution. The FDIC website has a tool to calculate your coverage.

Comparing CD rates across banks

CD rates vary significantly between banks. A large national bank might offer 4.0% APY on a 1-year CD, while an online bank might offer 4.8% on the same term. Over a year, that 0.8% difference adds up: on a $10,000 CD, it is roughly $80 more in your pocket.

Online banks and credit unions typically offer higher rates than brick-and-mortar banks because they have lower overhead costs. However, the tradeoff is that you cannot walk into a branch to manage your account. For most people, this is not a problem since CD management is simple and can be done by phone or online.

When shopping for CDs, compare the APY (not just the interest rate), the term length you want, and the early withdrawal penalty. A slightly higher rate is not worth it if the penalty is steep or if the bank has other restrictions you do not like. Check sites that aggregate CD rates from multiple banks to see what is available.

CDs versus savings accounts and money market accounts

A CD locks your money away for a set time in exchange for a higher rate. A savings account lets you withdraw anytime but usually pays a much lower rate. A money market account sits in the middle: it pays more than a savings account but less than a CD, and it lets you write checks or make a limited number of withdrawals per month.

Choose a CD if you have money you will not need for several months or longer and you want the highest rate available. Choose a savings account if you need quick access to your money or if you are building an emergency fund. A money market account works if you want some flexibility without giving up too much interest.

You can also use a combination: keep 3 to 6 months of expenses in a savings account for emergencies, and put money you will not need for a year or more into a CD. Some people build a CD ladder by opening multiple CDs with different maturity dates so that money becomes available at regular intervals without locking everything up for years.

Frequently Asked Questions

Can I add money to a CD after I open it?

No. A CD is a fixed deposit—you choose the amount when you open it, and that amount stays the same until maturity. If you want to deposit more money, you have to open a separate CD. Some banks let you open multiple CDs at once if you want to spread your money across different terms.

What if interest rates go up after I buy a CD?

Your rate stays the same for the entire term. If rates rise, you are locked into the lower rate you agreed to. This is the tradeoff for having a may provide rate: you benefit if rates fall, but you miss out if they rise. When your CD matures, you can open a new one at the higher rate.

Are CDs taxed?

Yes. The interest you earn on a CD is taxable income in the year it is earned (or the year it is credited to your account, depending on how the bank handles it). The bank will send you a 1099-INT form at tax time showing how much interest you earned. You report this on your tax return.

What happens if the bank goes out of business?

The FDIC takes over and pays you your principal plus accrued interest up to $250,000. This process usually takes a few weeks. You do not lose money as long as you stay within the insurance limit. This protection applies whether your CD has matured or not.

Can I transfer a CD to another bank?

You cannot transfer a CD directly. When it matures, you can withdraw the money and open a new CD at a different bank. If you need the money before maturity, you can withdraw it (and pay the early withdrawal penalty) and then deposit it elsewhere. Some banks offer CD specials to attract transfers, so it can be worth shopping around at maturity.