What does CD stand for?

CDs have been in the news recently, and for good reason: Interest rates are the highest they’ve been in more than 16 years, with the best 1-year CD rates reaching the upper 5% range. To put that in perspective: This time last year, the average rate on a 1-year CD was just 0.76%. That means CDs these days grow your money with six-and-a-half times more power.

But what if you’re confused about how to make all of this money magic work in your life? What if you hear the term “CD” and think it’s something you popped in your stereo back in the day?

Then this article is for you. We’ll cover the basics, including what CD stands for, how CDs work, and how to understand CD interest rates.

First things first: CD stands for certificate of deposit. Back in the day when people opened this type of account, they got an actual certificate spelling out the terms of their deposit — hence the name. (If you’re opening the equivalent of a CD at a credit union, the product is called a share certificate, or just certificate.) 

Most banks these days don’t give you a piece of paper anymore when you open a CD. Like so much else in life, the agreements are digital. But the accounts still function the same way. Which brings us to the next section of this article.

CDs are timed deposit accounts. They’re basically an agreement between you and the bank: You promise to keep your money in the CD for a certain period of time (known as the term), and the bank promises to pay the same interest rate for the duration. 

Unlike a savings account, you only make one deposit into a CD at the beginning of the term, and you can’t add money after that. Most CD terms are somewhere between three months and five years. If you want to withdraw your money before the end of the term, you can — but in most cases you’ll have to pay an early withdrawal penalty, which is usually equal to part of the interest you’d earn. CDs at FDIC-member banks are insured up to $250,000 per depositor. That means in the rare event something goes wrong at the bank, you’ll get your money back.

At the end of the term, the CD “matures,” which means you get to decide what you want to do with your money. You can either renew the CD at the current rate, move your money into a different account, or withdraw it if you’re ready to put it toward a goal. Most banks give you one week to make your decision. If you choose to do nothing, the CD will renew at the current interest rate.

The fixed interest rates on CDs give you a predictable return on your deposit and also help hedge against changes in the larger economy. If interest rates fall, for instance, you’ll still get the agreed-upon rate. On the flip side, interest rates may rise while your money is in the CD, which could make you feel like you’re missing out. (A CD ladder — a collection of CDs with different maturity dates — counters some of that risk.)

The rate of return on CDs is described in two ways: the interest rate and the APY. The interest rate is what percentage of interest the bank agrees to pay on your deposit. The APY, on the other hand, includes compound interest — which is interest the bank pays on the interest you’ve already earned. It has a snowball effect that makes your money grow even faster. 

Here’s an example of how a high APY affects your money. Imagine you have a $5,000 windfall. If you put it in a 1-year CD with a 5% APY, at the end of the year you’ll have earned $500 in interest — and all you had to do was open the CD.

Historically, interest rates have been higher on longer-term CDs, but that hasn’t been the case in the past year. The very best rates can be found right now on 1-year CDs, though rates on 6-month CDs are also quite good. However, there are reasons why you might choose a different term. For example, if you think interest rates may soon drop, you might want to lock in a slightly lower (but still good) interest rate on a 3-year CD or a 5-year CD that will stay consistent through an economic downturn.

Worth noting: Interest rates and APYs are calculated the same way on savings accounts. Interest rates on those accounts are also excellent right now, particularly on high-yield savings accounts offered by the best online banks. (Online banks pay higher interest in part because they don’t have the overhead of traditional banks that maintain many branches.) While the rates on savings accounts are variable, meaning they can go up and down at any time, this type of account gives you more flexibility because you can withdraw money at any time. 

Interest rates on all types of financial products have been rising over the past 18 months, ever since the Federal Reserve began raising the federal funds rate. The federal funds rate, also known as the benchmark borrowing rate, is what banks charge each other during overnight borrowing. Fed rate hikes, which are designed to cool inflation, have increased that target from near zero during the pandemic to between 5.25% and 5.50% as of early September. 

Any time the federal funds rate goes up, other interest rates tend to rise too. It’s created a lot of pain for borrowers, with mortgage rates in August reaching 22 year highs. But it’s been great news for savers, since rates have also skyrocketed on savings accounts and CDs.

Another factor contributing to higher interest rates: Banks are as eager as they’ve ever been to win your business. Bank deposits fell $472 billion during the first quarter of 2023, according to the FDIC, largely in response to a series of regional bank failures — wary customers started withdrawing their money.

However, in the months since, smaller banks have raised interest rates exponentially on savings accounts and CDs. Higher rates are one of the best marketing tools banks have to woo customers back and bring in deposits. 

When you decide to open a CD, you’ll want to consider the factors listed above — the term and APY — as well as whether there’s a minimum deposit requirement. Some banks let you deposit as little or as much as you want, while others may only let you open a CD with a certain amount of money, usually somewhere between $1,000 and $25,000.

Some banks require you to go to a branch to open a CD, while others allow you to open one online. Either way, opening a CD is a relatively simple process that takes just a few minutes:

1. Decide on a bank and term. You can compare APYs and deposit requirements online.
2. Gather your personal information. In addition to basics like your address and date of birth, in most cases you’ll also need your driver’s license number and social security number. Have your routing and account numbers handy from an existing bank account.
3. Make your one and only deposit. After you’ve set up the account, you’ll transfer money into it. Be certain about the amount since you typically can’t add or withdraw money later without paying an early withdrawal penalty.
4. Add the maturity date to your calendar. You’ll want to remember to make changes, if needed, during the window after the CD matures.

Dealing with your personal finances can be overwhelming, especially when it means locking away some of your money for a while. But CDs are a sure-fire way to grow your savings with almost zero risk. Some economists believe interest rates may be at or near their peak, since the Fed is expected to wind down its streak of rate hikes by the end of the year. That means right now might be the best time to open a CD and lock in one of the best rates in recent history. Your future self will thank you. 

Editorial Disclosure: All articles are prepared by editorial staff and contributors. Opinions expressed therein are solely those of the editorial team and have not been reviewed or approved by any advertiser. The information, including rates and fees, presented in this article is accurate as of the date of the publish. Check the lender’s website for the most current information.

This article was first published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at [email protected].