When to Choose a Certificate of Deposit Over a Savings Account
CDs offer higher interest rates than savings accounts. Here’s when it pays to open one.
You need money in the bank for emergencies and financial goals like buying a home. If you're looking for a risk-free way to earn interest on your cash (i.e., without investing in stocks or bonds), you may wonder whether it makes sense to put your money into a savings account or a certificate of deposit (CD). Both accounts let you grow your money without the risk of losing out on your principal contribution, but they work differently.
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Savings accounts vs. CDs
Savings accounts and CDs are similar in some ways: You open them at a bank and earn interest on the money in the account, for example. But there are some key differences.
With a savings account, the amount of interest you earn on your money can fluctuate and you typically get a lower interest rate than you would with a CD. However, you have the flexibility to withdraw funds from a savings account as you see fit. The required minimum balance to avoid fees is usually low, too. Some savings accounts don't have minimum balances at all.
With a CD, you earn more interest than you would in a savings account, and the interest rate you start out with is guaranteed for the duration of your CD's term. But you have to lock your money away for a preset amount of time, which could be six months, a year, two years, or more. If you withdraw funds from a CD before its term ends, you risk a penalty, the exact amount of which depends on your bank. For a one-year CD, for instance, you might lose three months of interest for removing money early.
Also, CDs often impose a minimum balance requirement to take advantage of their more favorable interest rates. That minimum deposit could be as little as $500 or as much as $5,000, depending on the financial institution at hand.
When a CD makes more sense than a savings account
There’s nothing wrong with keeping money in a standard savings account, but the upside of choosing a CD is that you earn more interest on your cash. It pays to choose a CD in these three cases:
1. You're certain you won't need the money right away
You’ll be penalized to the tune of several months of interest if you take an early withdrawal from a CD. But if you won’t need that money for the duration of your CD’s term, it pays to snag the higher interest rate.
2. You have additional funds in a regular savings account
You never know when you might need money in a pinch. If you don’t have separate funds set aside for emergencies, a CD becomes risky. The moment an unplanned bill pops up, you may be forced to take an early withdrawal and face an interest penalty. But if you have money for emergencies in a separate savings account, you should be fine putting additional cash into a CD.
3. You have enough money to make the minimum deposit requirement
Not everyone has enough cash to fulfill the minimum deposit requirement associated with some CDs. But if you have enough money, you might as well open a CD and snag the best interest rate available.
Saving in a CD lets you grow your money without taking on the risks associated with investing. Just make sure you understand the terms of your CD, like its length and early withdrawal penalties, before locking your money away.
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