Certificates of deposit (CDs) are a type of time deposit offered by FDIC-insured banks and NCUA-insured credit unions. They typically offer a higher interest rate than regular savings or money market accounts in exchange for keeping the funds deposited for a fixed period.
There are several types of CDs, each with different features to meet varying investment goals and preferences. We'll explore the differences below.
10 Types of CDs
I've invested in certificates of deposit since 1979. Most of the time I've chosen traditional CDs, although no-penalty CDs have been my investment of choice more recently. Here are 10 of the most common types of CDs available today:
1. Traditional CDs
The most common type of certificate of deposit, traditional CDs, offer a fixed interest rate over a specified term, usually ranging from 3 months up to 5 years or longer. Once the term ends, the CD matures, and the investor can withdraw the principal and earned interest. Early withdrawal penalties may apply if funds are withdrawn before the CD's maturity date.
As with most CDs, deposits and withdrawals cannot be made to a traditional CD in the same way one makes similar transactions with a savings account. One must invest a lump sum when opening the CD. If a withdrawal is made, the entire balance of the CD must be withdrawn.
2. No-Penalty CDs
No-penalty CDs allow investors to withdraw their funds before the maturity date without incurring any penalties. They typically offer lower interest rates compared to traditional CDs to account for the added flexibility. As noted above, only withdrawals of the entire balance are permitted.
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3. High-Yield CDs
These CDs offer a higher interest rate compared to traditional CDs. This terminology can be a bit confusing because a high-yield CD is a type of traditional CD. In addition, there's no official APY that a CD must offer to be deemed a high-yield CD. Generally speaking, most of the higher-yielding CDs come from online-only banks.
4. Callable CDs
Callable CDs give the issuing bank the option to “call” or terminate the CD before its maturity date, typically after a specified call protection period. Banks typically exercise this option if prevailing rates have fallen since the issuance of the CD. In this regard, a call feature of a CD protects the bank and the expense of the investor. If the bank exercises this option, investors receive their principal and any accrued interest.
Because the call feature favors the bank, callable CDs often offer higher interest rates to compensate for the risk of early termination. Generally, bank CDs are not callable. In my experience, brokered CDs (see below) are more likely to be callable.
5. Step-Up CDs
Step-up CDs feature periodic interest rate increases throughout the term of the CD, as specified in the initial agreement. This structure can be advantageous for investors who anticipate rising interest rates and want to capitalize on those increases.
As an example, U.S. Bank offers a 28-month step-up CD. The interest rate automatically increases every seven months. Note that this particular CD offers a significantly lower APY than what is available from the best CD rates. As such, a step-up CD, while initially appealing, may not be a very good deal.
6. Bump-Up CDs
These CDs allow investors to “bump up” or increase their interest rate once or multiple times during the term of the CD, usually in response to rising market interest rates. Unlike a step-up CD, where the bank automatically increases the rate periodically, with a bump-up CD, the investor decides when to take advantage of higher rates.
Bump-up CDs typically start with a lower initial interest rate compared to traditional CDs to account for the added flexibility. Ally Bank offers a bump-up CD, which it calls a “Raise Your Rate” CD.
7. Brokered CDs
Brokered CDs are purchased through a brokerage firm rather than directly from a bank or credit union. They often offer more competitive interest rates and may have unique features like secondary market liquidity, where investors can sell their CDs to other investors before the maturity date. As noted above, some brokered CDs have call features that investors should consider before making an investment decision.
Note too that selling a brokered CD before it matures may come at a cost. Brokered CDs do not have early termination penalties because investors don't have the option to terminate the CD with the issuing bank. If prevailing rates have risen since an investor purchased the CD, however, the current value of that brokered CD will have fallen. In this regard, the pricing of a brokered CD is very similar to that have a bond.
8. Jumbo CDs
Jumbo CDs require a larger minimum deposit, typically $100,000 or more. In exchange for this higher investment, they in theory offer higher interest rates compared to traditional CDs. In my experience, there is little difference between a traditional CD and jumbo CD today. In fact, the highest-rate CDs available today often require a very small minimum deposit.
9. Zero-Coupon CDs
These CDs do not pay periodic interest payments, but instead, they are sold at a discount to their face value. At maturity, the investor receives the full face value of the CD, with the difference between the purchase price and the face value representing the interest earned. In this regard, zeros are similar to T-bills.
10. Add-On CDs
Add-on CDs allow investors to make additional deposits into the CD after the initial purchase, which is normally not permitted. You can see an example of an add-on CD from First Horizon Bank. As is often the case with CDs offering unique features, the yields on this type of CD are often far below the best rates available.
Final Thoughts
Choosing a CD isn't only about finding the one with the highest APY. Think about how much you have to deposit into the account, how long you want the term to be, and which one of these CD types best suits your needs.
Ready to take a look at the best CD rates available? We track over 800 CD rates, including many of the types listed above. Rates are updated daily, but they also change often, so be sure to confirm rates with the bank or credit union's website.
