What Is a Certificate of Deposit?
A certificate of deposit (or CD) is considered a type of savings account, but a CD holds your money for a fixed time period in exchange for a higher rate of interest than a standard savings account.
While a savings account allows you to access your cash at any time, you typically purchase a CD for a set period of time during which you can’t withdraw the funds without paying a penalty. Typical CD terms can vary from one month to five years.
While CDs are generally considered cash equivalents from an investing standpoint, and therefore very low risk, they aren’t risk free. Rather, putting your money into a CD provides a balance between growth opportunity and risk management.
Is a Certificate of Deposit Just a Savings Account?
A CD has some similarities to a savings account, but several differences. It’s a financial product designed to help consumers save their money, and because CDs typically pay a fixed rate of interest they can offer savers a predictable return over time.
However, unlike a savings account, CD holders aren’t able to access the funds in their account whenever they feel like it — at least not without paying an early withdrawal penalty, in most cases. CD holders are also not allowed to deposit more money into an existing CD, generally speaking, although they can buy another CD.
In exchange for giving up the ability to freely withdraw the money in a CD, the institution rewards CD holders with higher interest rates than they’d see in a typical savings account.
What Is APY vs Interest Rate?
Note that when you deposit money into an interest-bearing account, you would earn an annual percentage yield or APY on those dollars. The APY is different than the interest rate because it takes compounding into account.
A financial institution may offer simple interest or compound interest. If the latter, then it also matters how often the financial institution compounds that interest, e.g. monthly or quarterly.
The longer the maturity date and the higher the minimum balance, the higher the annual rate. The average APY for a 5-year CD, as of February 1, 2023, is 1.21%. But a CD with a minimum deposit of $10,000 might have an APY as high as 4.0%, given the current high-rate environment.
What Is a Jumbo CD?
A jumbo CD, which typically has a minimum deposit of $100,000 or more, could offer an even higher rate.
Ordinary CDs are insured by the FDIC up to $250,000, as are jumbo CDs — but any amount in a jumbo CD above $250,000 is not FDIC-insured and subject to risk of loss.
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How Does a Certificate of Deposit Work?
When a customer goes to open a CD they’ll be asked to put down a lump sum, usually with a fairly high minimum deposit amount — perhaps $1,000 or $5,000.
The initial deposit placed in a CD is called the principal, because it is essentially a loan the consumer is offering to the bank. The interest the customer collects is what the bank pays for the privilege of borrowing their money.
Certificates of deposit also carry a “term,” much like a loan does; the term is the amount of time the funds must be left in the CD in order to glean the advertised interest rate.
The term might be as short as a few months or as long as a decade, and generally, longer terms carry higher interest rates. The day the term is over is also known as the CD’s maturity date.
Long story short: When opening a CD, a customer deposits a set amount of money for a set amount of time and agrees to leave it untouched in return for a relatively high fixed interest rate they’ll earn on the principal once the CD matures.
But how high, exactly, are the rates we’re talking about?
Certificate of Deposit Rates
Certificates of deposit are attractive savings options because they usually offer higher rates than the savings accounts, but are also a lower-risk option than, for example, investing in the stock market.
Since funds in CDs are FDIC-insured, account holders can rest with some assurance that their cash won’t simply disappear (as it might when invested in shares of a company).
As of Feb. 1, 2023, the national average rate for a normal savings account is 0.33% APY, whereas the national average rate for a 12-month CD is 1.28% APY. The national average rate for a 60-month CD is about 1.21%% APY. Online banks typically offer higher rates, closer to 4.0%.
But it’s possible to find CDs with even higher rates than that by shopping around.
Certificate of Deposits: Fine Print
There are a few more things it’s important to know about CDs before deciding to open one.
Generally, CDs automatically renew once the term is up, if the account holder doesn’t take the money out. Generally, the bank will roll over the existing CD into a new CD with the same term. (For example, a one-year CD whose funds aren’t collected on the maturity date would be rolled over into a new one-year CD.)
Most financial institutions offer CD holders a grace period, or a fixed amount of days after the maturity date, during which the account holder can decide whether to withdraw the funds, transfer them to a new account or CD, or allow them to roll over.
Finally, but importantly, most CDs are generally subject to an early withdrawal penalty, which is incurred if the money is accessed prior to the maturity date.
Early withdrawal penalties are determined by each financial institution. Depending on the policy, account holders could lose out on interest, or even lose some of their principal deposit.
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Certificates of Deposit: Pros and Cons
CDs can play an important role in an overall savings strategy because they balance growth and risk management.
But as with any financial product, CDs have both drawbacks and benefits, which should be considered carefully before opening one.
Pros of CDs
• Because CDs are FDIC-insured, they’re a relatively low risk account. The FDIC insures up to $250,000, which means if an FDIC-insured institution goes out of business, account holders with a CD would receive their principal and interest, up to $250,000.
• Higher interest rates are available for CDs than for similar savings vehicles, like savings accounts, making it easier to see a higher return on investment.
◦ For savers who are worried about spending down their savings, a CD provides a safe place to place cash, where it’s locked up for a certain period of time.
Cons of CDs
• Although CDs carry higher interest rates than some other types of savings vehicles they don’t have the same kind of earning potential that stock market investments can have. By investing your money in a CD you’re losing out on potentially much higher market returns (but you’re also protected from market risk).
• CD holders generally don’t have the ability to withdraw their money at any time, at least without being subject to a penalty. That makes a certificate of deposit a poor choice for certain savings goals, like an emergency fund, which should be readily available.
◦ Savers will owe taxes on the earnings in the account, which effectively lowers the amount you earn. Be sure to take this into consideration shopping around for the best APY.
Where to Open a Certificate of Deposit
Certificates of deposit are available from a wide variety of financial institutions, including national and regional banks, credit unions, and online-only financial institutions.
Shopping around can help ensure consumers find the best rates and most favorable terms for their needs.
That said, there are also some alternatives to opening a certificate of deposit that are worth considering carefully.
Alternatives to Opening a Certificate of Deposit
Although CDs are a great way to earn interest, they’re far from the only high-interest account option out there. Here are a few options to mull over.
High-Yield Checking and Savings Accounts
Although typical savings accounts offer a relatively low interest rate, high-yield savings and checking accounts are available from some banks.
This option helps consumers combine growth potential with the ability to access their money as they need it, and can be a good alternative to CDs for those who aren’t ready to lock away their money for a year or more.
Certain high-yield accounts may offer a higher APY. However, there may be fine print involved requiring that savers meet certain terms in order to maintain that rate, such as making a minimum number of transactions per month or maintaining a minimum account balance.
It’s a good idea to review all the account terms carefully before opening any kind of financial account.
Money Market Deposit Accounts
Money market deposit accounts are another option which, similarly to CDs, tend to offer higher interest rates than your typical savings account does.
And unlike CDs, money market deposit account holders are generally allowed to write checks or process debit transactions against their funds, which are still covered by FDIC insurance.
While money market deposit accounts can earn higher interest rates than traditional savings accounts, there are monthly restrictions on the number of deposits and withdrawals.
Money market deposit accounts might require a high minimum balance in order to avoid monthly fees.
Stock Market Investments
Finally, for consumers focused on growing their money in the long-term, investing in the stock market can provide a lot of potential for growth.
Historically, the S&P 500 — an index tracking 500 of the largest corporations in the U.S. — has seen an average annual return of 13.8% over the last decade.
Of course, an investment account is very different from a savings account or CD in that there is no FDIC insurance on the funds.
Investments in the stock market are vulnerable to market fluctuation, and there’s no guarantee that investments will be safe and make money.
It is important to remember that investments have no guarantee and are subject to potential losses.
That said, many financial professionals and advisors still recommend long-term investing as one of the best ways to grow wealth over time and as a part of an overall plan for long-term financial goals like retirement.
The Takeaway
CDs, money market deposit accounts, and even plain-old checking and savings accounts can all be important parts of a sound financial strategy. CDs in particular can be good vehicles to help augment savings for shorter-term financial goals.
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SoFi members with direct deposit activity can earn 4.20% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.
As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.
SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.20% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.
SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.
Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.
Interest rates are variable and subject to change at any time. These rates are current as of 10/31/2024. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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