How To Pick the Right CD Term for Your Needs

One of the most important decisions you need to make when investing in a certificate of deposit (CD) is the date you want it to mature. CDs come in different durations, from months to years. If you choose a term that's too short, you won't get as good an interest rate, but if it's too long, you may have to pay an early withdrawal penalty if you need to withdraw your money before it matures. The key is to find the happy medium, a CD term that works best for you.

Key takeaways

  • Certificates of deposit (CDs) come in many different terms or lengths to maturity.
  • A major factor to consider in choosing the right CD term is how soon you expect to need repayment.
  • If you have to cash out a CD before its term is up, you may have to pay an early withdrawal penalty, which could cost you all of your interest and even some of the principal.
  • Building a CD ladder can help you avoid penalties because it divides your investment into multiple CDs maturing on staggered dates.

Find the length of CD that suits your needs

When choosing the term of your CD, you should first think about how long you can lock your money away without touching it. You wouldn't put your emergency fund savings into a CD because you might need the money before the CD matures. Likewise, if you're saving for a down payment on a home that you know you won't be ready to purchase for another three to five years, you wouldn't choose a six-month CD when you could get a lower interest rate much higher. over three or five years.

If you're saving for retirement in a decade or two, you might want to invest in a longer-term CD, especially if you're risk-averse and don't want to put all your money in the stock market.

What lengths of CDs are available?

CD terms typically range from one month to 10 years, and sometimes longer.

The longer the term, the higher your interest rate is likely to be. Indeed, the longer the duration, the greater the penalty in the event of early withdrawal can also be significant.

Get the best interest rates

Once you've decided the CD term you want, it's helpful to shop around to find a bank or credit union that offers the best interest rate for that term. You should always make sure that the bank or credit union is insured by either the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). With either agency, your total deposits at that financial institution are insured up to $250,000, and if you have joint accounts, that amount is doubled. Coverage is automatic.

As of April 2022, for deposits less than $100,000, average CD rates nationwide ranged from 0.03% for a one-month CD to 0.32% for a five-year CD. But rates can vary significantly from one financial institution to another. Generally, online banks offer higher returns than physical banks.

Also note that some financial institutions pay higher interest rates on CDs over a certain size, such as $10,000. Some also offer jumbo CDs, usually for deposits of $100,000 or more, which offer their highest rates.

Minimum Deposit Requirements

You'll also want to check the bank or credit union's minimum deposit requirements. Most require a minimum deposit of at least $500 to purchase a CD and many want $1,000 or more. Keep in mind that, unlike a savings account, you typically only fund a CD once, when you open it. (There is a specialized type of CD that allows additional deposits, called a top-up CD, but it is much less common.)

Early Withdrawal Penalties

Another provision to check is whether the CD has an early withdrawal penalty, in case you need to withdraw your money early – and, if so, how it is calculated.

These fees vary depending on your particular CD, its term, and the issuer. The longer the duration of the CD, the greater the penalty will normally be. So, for example, the penalty for a five-year CD is much higher than for a three-month CD. Some issuers will charge you for all the interest you earned and even subtract a portion of your principal if you didn't earn enough interest to cover the entire penalty.

If you're not sure how long you can leave your CD intact, note that some banks offer liquid CDs or penalty-free CDs, although they pay less interest as a trade-off.

Leveraging CD Scale

One way to reap the benefits of CDs in both the short and long term is to use a CD ladder. Laddering is a strategy of spreading your money across multiple CDs with different terms.

For example, instead of purchasing a single five-year CD with $5,000, you could invest $1,000 each in one, two, three, four, and five-year CDs. This way, you'll still have a CD maturing within a year, while still getting a higher rate on at least some of your money. When your one-year CD matures, you invest the money in a new five-year CD. One year later, you invest the proceeds from your matured two-year CD into a new five-year CD, and so on.

A ladder can also prevent you from locking up all your money at a low rate.

What happens when a CD matures?

By law, if your CD has a term of one year or more and you have not chosen to renew it automatically, the financial institution must notify you when it is about to expire. At this point, you will have the option to transfer the money to another CD, transfer it to another account, or simply take it in cash. If you don't take action before the deadline set by the financial institution, they will usually place the money in a new CD and hold it until that CD matures.

What is a brokered CD?

Brokered CDs are certificates of deposit issued by banks but sold by brokerage firms and independent sales representatives. They may pay higher rates than CDs sold directly by banks and credit unions, but may also be riskier. Before purchasing one, make sure you are dealing with a reputable company. Also make sure the CD is federally insured.

What is a callable CD?

Some certificates of deposit, like some bonds, have a provision allowing the issuer to call them before maturity. An issuer may do this, for example, if you have a long-term CD with a high interest rate and the interest rates have fallen since you purchased it. You'll get your money back and all the interest you've earned so far, but you'll have to invest the money elsewhere, probably at a lower rate. So when you're buying a CD, it's worth asking if it's callable.

The essential

CDs are available in a wide variety of terms or lengths. The trick to choosing one is finding the right balance between a short-term CD (which lets you withdraw your money sooner) and a long-term CD (which will pay a higher interest rate). You can also spread your investment across several CDs of different durations to cover your stakes.

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