What CD rates are and how they're set

A CD rate is the interest percentage a bank or credit union pays you for locking your money away for a set time. When you open a CD, you agree to leave your deposit untouched until the maturity date—usually anywhere from three months to five years. In exchange, the bank guarantees you a fixed rate of return, paid either monthly, quarterly, or at maturity.

Banks set CD rates based on what the Federal Reserve does with the federal funds rate, which is the interest rate banks charge each other for overnight loans. When the Fed raises rates, banks typically raise CD rates to attract deposits. When the Fed cuts rates, CD rates fall. A bank also considers how much money it needs to borrow, how much competition exists in your area, and the length of the CD term—longer terms usually pay more because your money is locked up longer.

The rate you see advertised is the Annual Percentage Yield (APY), which includes the effect of compounding. This is the actual return you'll earn over a year if you hold the CD to maturity and don't withdraw early.

Key Takeaways

  • CD rates move with Federal Reserve decisions, so rates rise when the Fed raises its benchmark rate and fall when it cuts.
  • Longer CD terms almost always pay higher rates than shorter ones at the same bank, because you're committing your money for more time.
  • Different banks offer different rates for the same CD term, so comparing rates across banks can add hundreds of dollars to your return.
  • The rate is locked in when you open the CD and does not change, even if market rates move up or down before maturity.
  • Early withdrawal usually means losing some or all of the interest you've earned, so only use a CD for money you won't need before the maturity date.

Why CD rates vary between banks

Two banks offering a one-year CD on the same day might pay 4.50% and 5.25%—a difference that matters. Banks compete for deposits by raising rates, but they don't all compete equally. A large national bank with plenty of deposits may offer lower rates because it doesn't need to attract as much new money. A smaller bank or online bank with fewer deposits might offer higher rates to pull money in.

Online banks typically offer higher CD rates than brick-and-mortar banks because they have lower overhead costs and can pass savings to customers. Credit unions sometimes offer competitive rates to members. The bank's own financial health and lending strategy also matter—a bank that needs to fund more loans will pay more for deposits than one that doesn't.

This is why shopping around is worth your time. A 0.75% difference on a $10,000 CD over one year means $75 more in your pocket. Over five years, that gap widens significantly.

How the Federal Reserve affects CD rates

The Federal Reserve doesn't set CD rates directly, but its decisions ripple through the entire banking system. When the Fed raises its benchmark rate, banks have to pay more to borrow from each other, so they raise the rates they offer on deposits—including CDs—to stay competitive. When the Fed cuts rates, banks lower CD rates because they can borrow more cheaply.

The lag between a Fed decision and a change in CD rates is usually quick—often within days or a week—but not instant. Some banks move faster than others. If you're watching rates and the Fed just cut, you might see CD rates drop within a few days at online banks, while some regional banks take longer to adjust.

This matters for timing. If the Fed is expected to cut rates soon, locking in a CD now captures today's higher rate. If the Fed is expected to raise rates, you might wait to open a CD later, though there's no may provide rates will actually go up.

CD term length and rate differences

A three-month CD pays less than a one-year CD at the same bank. A one-year CD pays less than a five-year CD. This pattern holds almost universally because banks pay you for tying up your money longer. The longer you commit, the more certainty the bank has about how to use your deposit, and the more it will pay.

The difference between a one-year and two-year CD might be 0.25%, but the difference between a one-year and five-year CD could be 0.75% or more. However, this relationship can flatten or even invert in unusual market conditions. If the Fed is expected to cut rates sharply, a five-year CD might not pay much more than a one-year CD because the bank expects rates to fall.

Some banks also offer "bump-up" or "step-up" CDs where the rate increases at set intervals, or CDs where you can bump the rate once if market rates rise. These usually start at a lower rate than a standard CD but give you a way to capture higher rates if they appear before maturity.

What happens to your rate if market rates change

Once you open a CD, your rate is locked. If you open a one-year CD at 5.00% and the Fed cuts rates the next week, your rate stays 5.00% until maturity. You're protected from rate drops. But if rates rise, your CD still pays 5.00%—you don't benefit from the increase.

This is the trade-off of a CD: certainty in exchange for inflexibility. You know exactly what you'll earn, but you can't adjust if conditions change. If you need access to your money before maturity or want to move it to a higher-paying CD, you'll pay an early withdrawal penalty, which typically eats into or eliminates your interest earnings.

Some banks publish their early withdrawal penalties upfront—for example, "90 days of interest" or "1% of the deposit." Others don't disclose the penalty until you ask. Always confirm the penalty before opening a CD, because it affects whether breaking the CD early makes financial sense.

How to compare CD rates across banks

Start by listing the CD term you want—say, one year. Then check rates at your current bank, at least two online banks, and a local credit union. Write down the APY, the early withdrawal penalty, and whether interest compounds monthly or at maturity. A higher rate means nothing if the penalty is so steep that breaking the CD early would wipe out your gains.

Pay attention to deposit insurance limits. The Federal Deposit Insurance Corporation (FDIC) insures up to $250,000 per depositor per bank. If you're depositing more than $250,000, you'll need to split it across multiple banks or use a brokered CD, which can be held at multiple institutions under one account. Credit unions are insured by the National Credit Union Administration (NCUA) with the same $250,000 limit.

Also check whether the bank requires a minimum deposit. Some banks require $500 or $1,000 to open a CD, while others have no minimum. Online banks often have lower minimums than traditional banks.

When CD rates are high versus low

CD rates reflect the broader economic environment. When inflation is high and the Fed is raising rates to combat it, CD rates climb. When the economy slows and the Fed cuts rates to stimulate borrowing, CD rates fall. Rates in 2023 and early 2024 were significantly higher than they were in 2021 and 2022 because the Fed raised rates aggressively to fight inflation.

There's no way to predict exactly when rates will peak or bottom, but you can watch Fed announcements and economic forecasts to get a sense of direction. If multiple forecasters expect the Fed to hold rates steady or cut them, locking in today's rate protects you. If the consensus is that rates will rise, waiting might pay off—though waiting also carries the risk that rates don't rise as expected.

One strategy is to ladder CDs: open multiple CDs with different maturity dates so that some mature each year. This lets you reinvest maturing CDs at whatever rates are available at that time, rather than betting on a single rate environment.

Frequently Asked Questions

Can I withdraw money from a CD before it matures?

Yes, but you'll pay an early withdrawal penalty that usually costs you some or all of the interest earned. The penalty varies by bank and CD term—a three-month CD might charge 30 days of interest, while a five-year CD might charge 150 days. Always ask for the penalty before opening a CD so you know the cost of early access.

Why do online banks pay higher CD rates than big banks?

Online banks have lower operating costs because they don't maintain physical branches. They pass those savings to customers by offering higher rates on deposits. They also compete aggressively for deposits since they can't rely on walk-in customers. Big banks often prioritize convenience and brand recognition over rate competitiveness.

What's the difference between APY and interest rate?

The interest rate is the base percentage the bank pays. APY includes the effect of compounding—how often interest is calculated and added back to your balance. If a CD compounds monthly, you earn interest on your interest, which is why APY is always equal to or higher than the stated rate. Always compare APYs, not stated rates.

If I open a CD now and rates go up next month, can I get the higher rate?

No, your rate is locked for the entire term. However, some banks offer "bump-up" CDs that let you increase the rate once if market rates rise. These start at a lower rate than standard CDs, so you're trading initial yield for flexibility. Check whether your bank offers this option if rate increases are a concern.

How much of my CD is protected if the bank fails?

The FDIC insures up to $250,000 per depositor per bank, and CDs are covered the same as savings accounts. If you have $250,000 in a CD at Bank A and $250,000 in a CD at Bank B, both are fully insured. If you have $500,000 at one bank, only $250,000 is covered. Credit unions are insured by the NCUA with the same limits.