CD terms: Everything to know

While many people are worried about the economy, with persistent issues like inflation and high interest rates, the current environment can also benefit some savers and investors. In particular, higher interest rates from the Federal Reserve have generally translated into higher interest rates for certain banking products, including for certificates of deposit (CDs).

By opening CD accounts, savers can earn a fixed interest rate for a designated period of time. For example, a 1-year CD with a 5% annual percentage yield (APY) means that your money in that account would grow by 5% after a year. So $10,000 would earn $500 in interest.

But a 1-year CD isn't the only CD term to choose from. Some CDs last for a few months, while others pay a fixed interest rate for several years. 

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What are CD terms and how do they work?

Choosing among different CD terms can affect the interest rate you receive and your liquidity, so it's important to understand how different CD terms work. Basically, the CD term is the amount of time you agree to leave your deposit in the CD account while earning interest at the agreed-upon rate.

That said, there can be some nuances depending on the type of CD you choose. Brokered CDs, for example, can potentially be sold before maturity. So while you might invest in, say, a 5-year brokered CD, it's possible that you might liquidate that holding after four years, before the term ends. 

That "comes with the potential of losing or gaining some principal investment, depending on the direction of interest rates," says Dr. Anthony Williams, an LPL-affiliated financial advisor and co-founder of Galene Financial.

No-penalty CDs also offer the opportunity to pull your money out of the CD account without forfeiting interest. But they still come with terms; an 11-month no-penalty CD, for example, will pay interest for up to 11 months if you leave your money there. This type of CD could be a good fit for someone looking for flexibility while still earning more interest than a savings account, says Billy Cho, market leader at Citi. However, no-penalty CD rates tend to lag regular CD rates. 

Opening a regular high-yield CD and giving up some flexibility by agreeing to keep your money in a CD for the full term (if you want to avoid penalties) is still the best way to increase your returns. "This makes sense for someone who is confident that they won't need to access the funds for the entire duration of the agreement," says Cho.

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What are the common time frames for short-term vs. long-term CDs?

You don't have to lock up your money for long if you don't want to. CDs come in both short and long terms. CD terms can vary by provider, but in general, there's a common distinction between short-term CDs and long-term CDs.

"Short-term CDs are typically considered to be products that offer terms between 30 days and one year. Long-term CDs typically offer terms that range from one to five years," says Cho.

In some cases, you can even find long-term CDs that go up to 10 years, adds Williams.

Typically, the longer the term, the higher the interest rate. "However, because the yield curve is currently inverted, we are seeing some unusual rate activity. For instance, you might see that you don't necessarily get higher returns for 5-year and longer CDs than you do, for instance, with a 3-year CD presently," says Casey Craig, an LPL-affiliated financial advisor, accredited investment fiduciary and founding partner of Highlander Financial Group. 

When is a short-term CD generally better?

Even in more traditional times where short-term CDs have lower interest rates than long-term ones, the balance between liquidity and APY makes short-term CDs a better fit for some savers.

"If you are saving for a specific upcoming expense, such as a vacation, down payment, or emergency fund, a short-term CD can offer a safe and secure way to earn interest while ensuring your funds will be available within a shorter time frame," says Williams.

Plus, with the option to take your money out of short-term CDs sooner than long-term CDs (assuming you don't want to pay a penalty), you can position yourself to re-invest in more attractive options. For instance, "if interest rates are expected to rise soon, opting for a short-term CD allows you to take advantage of potential rate increases sooner," adds Williams.

When is a long-term CD generally better?

For some savers, the stability and relatively high yields of long-term CDs make these good places to park money.

"Long-term CDs are typically more advantageous when you have longer-term financial objectives and can afford to lock up your funds for an extended period," says Williams. A longer term "offers the benefit of a fixed interest rate over a more extended period, shielding you from potential rate fluctuations."

For example, he says, someone saving money for their children's future education might choose a long-term CD.

In some cases, long-term CDs can also be a good savings hack.

"They're a great choice for those who need a bit more boundaries around their savings," says Cho. "For example, if you're saving for a specific goal that has a set date and you know you might be tempted to dip into your cash for other things, putting your money into a long-term CD, which comes with penalties for early withdrawals, makes accessing that money a bit less tempting."

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Choosing the right CD terms

Both short- and long-term CDs have their pros and cons. But you don't have to choose just one. Some people build what are known as CD ladders, which include both short- and long-term CDs. 

CD ladders help create a continual flow of liquidity. As short-term CDs mature, you can reinvest in long-term CDs, because those previously purchased long-term CDs are closer to maturity at that point. 

You may also want to consider other types of accounts, like high-yield savings accounts or money market accounts. These generally have lower yields than CDs, but they can have more liquidity.

Ultimately, the choice choosing the right account for your savings depends on factors like your liquidity needs and desire for stability. Compare different interest rates, terms, and account features to see what works best for you. Learn more about currently available CD options with great rates here.