What is a high-yield CD and how does it work?

If you have savings you won’t need to tap into for a while and want to earn more on your money than you could with a regular savings account, a high-yield certificate of deposit, or CD, could be a good option.

Here’s what high-yield CDs are, how they work, how to make the most of your deposit, and how they compare to other types of savings accounts.

What is a high-yield CD?

A certificate of deposit, or CD, is a special type of savings account offered by banks and credit unions that comes with a fixed interest rate (APY) on your balance for a predetermined period. Generally, you must keep your funds in the CD for the length of time specified (until maturity), to avoid a penalty.

A high-yield CD is a CD that typically offers one of the highest available APYs across financial institutions. CDs with maturity dates that are further out usually offer the highest interest rates available. Depending on market conditions, a high-yield CD can potentially earn you one of the highest APYs available on your deposit compared to a regular savings account. (However, a high-yield savings account may offer competitive rates to a CD and could even outpace a CD during its fixed term.)

While the APY on a high-yield CD remains fixed during its term, the yields offered will vary based on the type and term length of the CD.

CDs offered by banks are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC).¹ CDs offered by credit unions are insured up to $250,000 by the National Credit Union Administration (NCUA).²

How does a high-yield CD work?

CDs, also known as “time deposits,” require you to make a one-time deposit of money into the account at the beginning of the term and keep it there for a set period of time. Generally, CD terms can range from three months to five years. The end of that time period is what’s known as the “maturity date.” While most CDs require around $1,000 to open, some have no minimum deposit requirements, and others, such as certain higher-yielding CDs can have minimum balance requirements of up to nearly $100,000.

If you withdraw your deposit before the CD matures, you may have to pay an early withdrawal penalty—the size of which will vary depending on your financial institution. Some financial institutions may agree in advance to waive the early withdrawal penalty if you have held the CD for a minimum period. Regardless, it’s important you find out what the penalty is in advance should you need to withdraw funds before the maturity date.

Consider selecting a CD maturity date based on your expected needs, and after considering the pros and cons. For example, if in two years you think you might need the money you’re considering depositing, it’s a good idea to compare the terms of CDs offered on the assumption that you’ll withdraw the money at that time. If you think that interest rates will rise or you might need access to that money sooner, then locking into a CD may not be the best decision for you.

There are many factors to consider, which starts with a good understanding of the types of CDs that are available.

Types of high-yield CDs

Generally, a high-yield CD is any CD that offers a higher interest rate, however, there are specific types of CDs that typically fall under the high-yield CD umbrella. Here are some of the more common types of CDs you may encounter:

Standard CD

Generally, a standard CD is a widely available 3-month CD with no extra features beyond a higher yield when compared to a regular savings account.

No-penalty CD

No-penalty CDs allow you to withdraw your money before the maturity date without penalty. Generally, no-penalty CDs offer lower APYs than standard high-yield CDs and typically come with shorter terms—usually one year.

Bump-up CD

With most CDs, your APY remains fixed until the account reaches maturity, which could cause you to miss out on potential earnings if interest rates increase during the term of your CD. With a bump-up CD, you’re allowed to request a one-time rate increase during the term, allowing you to take advantage of rising interest rates to some degree. Keep in mind, the rate you start with on a bump-up CD may be lower than that of a standard CD initially.

Step-up CD

Similar to a bump-up CD, step-up CDs also allow you to take advantage of rising interest rates. However, the difference is that the financial institution will increase your interest rate by a certain percentage at varying intervals automatically—without
you having to ask.

Add-on CD

While most CDs won’t allow you to make additional deposits beyond your opening balance, add-on CDs let you deposit additional money into your CD after opening your account and before maturity, based on the terms of the account.

Jumbo CD

If you have a large amount of money to deposit and a specific short-term goal in mind, jumbo CDs typically require at least a $100,000 deposit, although some banks may require less. Jumbo CDs aren’t too common and may or may not offer “jumbo” yields compared to other CDs with the same terms. So, be sure to compare CD and high-yield savings rates to make sure you’re getting a better yield for depositing a larger amount.

As you compare different high-yield CD and other savings options, consider when you may need the money, along with the available features that are most important to you.

Building a high-yield CD ladder

In some cases, it could make sense to use multiple CDs to achieve your short- or long-term savings goals. For example, building a CD ladder is a strategy that involves splitting up your deposits into CDs with different maturity dates.

A CD ladder can allow you to take advantage of higher long-term rates without locking up all of your funds for too long. By carefully staggering your maturity dates, you can make sure you’re never more than a few months away from being able to access your money without penalty. You could also split up your cash into different types of CDs to take advantage of the various features different CDs have to offer.

The CD ladder strategy is best when you want the certainty of a fixed rate yield over time, especially if you’ll need to depend on a reliable stream of income, such as in retirement.

Pros and cons of high-yield CDs

As with any other financial product, there are both benefits and drawbacks to high-yield certificates of deposit. Here’s what you should keep in mind before opening an account.

Pros of high-yield CDs

• Potentially higher yields: Compared to a regular savings account and even some high-yield savings accounts, a high-yield CD could offer a better yield.

• Locked-in rate: While CDs allow you to lock in your money for a set period of time, you’re also locking in a fixed interest rate, which means you’ll keep that same rate, even if market rates go down.

• Safety and security: CDs can be a safe place to invest your savings if you’re looking for a
  minimal risk of loss. Like other deposit accounts, CDs are insured by the FDIC (if you open them at a bank) or NCUA (if opened at a credit union), which means that if the institution offering the CD fails, totalCD deposits of up to $250,000 will be guaranteed.¹

• Predictable investment return: A CD ladder offers guaranteed rates of return, and if you do some research, you’ll find a variety of high-yield CDs that offer features that can help you accomplish some of your short- and long-term financial goals.

Cons of high-yield CDs

• Liquidity: Unless you opt for a no-penalty CD, you generally won’t be able to access your savings until the CD maturity date without incurring a penalty.

• Automatic renewals: Generally, CDs are set up to renew automatically once they reach maturity. If you want to have access to your funds upon maturity, notify your bank or credit union of this in advance. Otherwise, your fund could be rolled over into a term and your money held for longer than you had planned.

• Relatively lower returns: Generally, high-yield CDs offer lower returns compared to other
  investment options because of the reduced risk of the investment. If you want to maximize your returns and are willing to take on more risk to do so, you might consider other alternatives.

• Inflationary risk: While locking in a fixed rate can be beneficial during periods of decreasing rates, it will work against you in a rising interest rate environment. If you have savings locked in at a fixed yield over a longer term, the risk of not keeping up with inflation could be a concern. If the rate of inflation is outpacing the yields on CDs, it might be worth investing your savings differently or focusing on paying down debt instead.

High-yield CD vs. High-yield savings accounts

If you want a better rate of return on your regular savings without locking up your money in a CD for a set period of time, you may want to consider a high-yield savings account. When comparing high-yield savings accounts to high-yield CDs, you’ll notice that rates vary across financial institutions.

Depending on the economic environment, some high-yield savings options may offer rates that closely compete with (or exceed, in some cases) high-yield CDs. On the other hand, some banks and credit unions may offer high enough CD yields that, depending on your timeframe and savings goals, a CD may be a better choice—especially if you need to plan for a guaranteed rate of return.

Alternatively, you could split up your cash, putting some of it in CDs of various maturities and yields, and some of it in a high-yield savings account. This strategy could help you take advantage of higher-yielding CDs without sacrificing too much of your liquidity. It’s important to take your time to research all your options and consider both the advantages and disadvantages of each one to determine the best fit.

The bottom line

If you’ve got some money you won’t need to access for an extended period and want to earn a potentially higher, fixed rate of interest, a high-yield CD could be a good option. As long as you keep the account until it matures, CD’s offer a guaranteed rate of return over a set period of time and a chance to boost your savings. A high-yield CD could be of particular interest if you expect interest rates to decrease in the near future. However, in a rising interest rate environment, it might be better to consider high-yield savings accounts, or focus on CDs with short maturities to avoid missing out on higher interest rates on long-term CDs. Whatever you do, to make the most of your money it’s important that you take the time to consider the different financial instruments available in the context of your own financial situation.

¹ FDIC-insured up to $250,000 per depositor for each ownership category.
² NCUA-insured up to $250,000 per share owner for each account ownership category.