Opening a certificate of deposit (CD) account can be a good way to earn interest on your money with relatively little risk. Traditional banks, credit unions, and online banks can all offer CDs to savers with varying rates and terms. Understanding the history of CD rates and how they work can help with deciding whether they're a good savings option.
- A certificate of deposit allows savers to earn interest over a specified time frame. For that reason, they're also referred to as "time deposit" accounts.
- CD interest rates can vary greatly from one financial institution to another, though online banks can often offer higher rates.
- The CD term and amount deposited can influence how much interest savers earn on CDs.
- Getting the best CD rates means shopping around online to see what different banks and credit unions have to offer.
How Do CD Interest Rates Work?
A CD account is a time deposit account, in which you agree to save money with a bank or credit union for a certain time period and the bank or credit union pays you interest. In terms of how banks and credit unions set CD rates, this is ultimately influenced by movements in the federal funds rate. The federal funds rate represents the interest rate at which banks lend money to one another overnight.
Banks can use the federal funds rate and other index rates as a benchmark for determining how much interest to offer to savers on CD accounts, savings accounts, and money market accounts. When the Federal Reserve raises interest rates, banks can charge higher rates for loans and credit cards. But they can also offer higher rates to savers. Likewise, when the Fed cuts rates, banks can reduce the interest rates paid out on deposit accounts.
That's part of how CD interest rates work. It's also important to understand how rates apply to different CD products. Banks can assign rates to CDs based on:
- Maturity terms
- Minimum deposit requirements
- CD type
For example, banks may reserve the highest CD interest rates for CDs with the longest maturity terms or the highest minimum deposit requirements. The higher rate acts as an incentive to get savers to hold more money with that bank for longer periods of time.
There can also be rate differences across different types of CDs. For instance, a raise-your-rate CD or bump-up CD allows savers to increase their rate once or twice during the maturity term. Step-up CDs raise their rates automatically. Again, the potential to earn higher rates allows banks to attract customers and encourages them to save.
CDs assume that you'll leave the money in your account until maturity; withdrawing money before maturity could trigger a penalty.
History of CD Interest Rates
CD interest rates have changed over time, typically following movements in the federal funds rate. The 1980s is largely viewed as a heyday for CDs, with interest rates hovering near or above 10% for much of the first half of the decade. In March 1980, for example, six-month jumbo CD rates reached 17.74%, a rate that would be virtually unheard of today.
High CD rates in the early part of the 1980s are often attributed to the periods of higher inflation the country was experiencing during that time. June of 1979 saw the inflation rate reach 11%, a precursor to what would arguably be the worst recession in U.S. history, after the recession of 2007 to 2009. In response to steadily rising prices, the Federal Reserve opted to raise interest rates.
Rate hikes are intended to have a cooling effect when the economy is overheating. They can also help to rein in inflation because higher rates make it more difficult for consumers to borrow. Lenders may also tighten borrowing guidelines. When people spend less, prices tend to drop. A side effect of those rate hikes was a spike in CD interest rates, with savers reaping the benefits.
CD rates continued to remain fairly high throughout the 80s, briefly reaching double-digit numbers in 1989. But as the 1990s got underway, CD rates began to stabilize and level off. Between January 1990 and January 2000, the six-month jumbo CD rate went from 8.17% to 6.15%. By January 2010, the rate for that same six-month CD had shrunk to just 0.29%.
That's not necessarily surprising, considering that the economy was just beginning to emerge from the Great Recession. The Federal Reserve had slashed rates in order to encourage consumer spending and borrowing. As a result, banks were paying much lower rates to savers. As of April 2022, six-month CDs are paying 0.10% while 60-month CDs are paying 0.32%.
Jumbo CD accounts may feature tiered rates that pay out a higher rate as your balance increases.
Can CD Rates Rebound?
Double-digit CD interest rates are a thing of the past and are likely to remain that way. Even if the Federal Reserve were to raise rates in response to increasing inflation, it's unlikely that banks would be quick to pay out 10%, 15%, or more in interest to CD savers. Does that mean, then, that CDs are not worth savers' time?
Not necessarily. Saving in CDs can still be a good option for people who want a secure place to keep their money while earning a virtually guaranteed rate of return. CDs can be safer than investing in the market and may offer a better rate of return compared to a savfings account or money market account. So where do you find the best CD rates?
Consider a raise-your-rate or step-up CD if you think CD rates are likely to rise during the period in which you're saving.
Generally, online banks can offer higher CD rates for savers than traditional banks or credit unions can. Online banks often have lower overhead costs, which means they can afford to pass those savings on to their customers in the form of better rates. They can also charge fewer fees than brick-and-mortar banks or credit unions do.
Why Were CD Rates So High in the '80s?
High CD rates in the 1980s were a byproduct of the Federal Reserve's attempts to reduce inflation by raising interest rates. As the federal funds rate increased, banks and other financial institutions offering CDs followed suit and paid out higher rates to savers. The behavior of the Savings and Loan industry—offering absurdly high CD rates to attract deposits—was also an important factor.
Where Can I Find the Highest CD Rates?
Getting the best CD rates often means looking at online banks, which can pay out higher rates to savers than traditional banks and credit unions can. When comparing CD rates, also consider the minimum deposit requirements and the CD term you'll have to commit to in order to earn that rate.
Why Are CD Rates So Low?
CD interest rates track changes to the federal funds rate. When the Federal Reserve cuts interest rates and they remain low, banks can pay out less in interest to CD savers.
The Bottom Line
CD rates reached their heights during the turbulent economic situation of the 1980s before gradually settling down to where they are today. Opening one or more CD accounts is something you might consider if you want to set aside money for a new car, vacation, or another financial goal. Shopping around for the best CD rates can help you find the best option for saving.