When you're looking for a certificate of deposit (CD), you'll see that many banks and credit unions offer them with different term lengths, or maturities. Each provider can set their own terms, as well as their own interest rates, and there is a wide variation among providers in this regard. However, a few term lengths have become fairly standard. In this article, we'll take a look at the most common CD terms and explain how to build a CD ladder using CDs of staggered terms as a hedge against interest rate changes.
- Certificates of deposit (CD) come in a variety of terms, or maturities.
- A CD's term determines long you must leave your money in the CD before you have cost-free access to it again.
- CD issuers, such as banks and credit unions, are free to set their own terms. Among the most common CD terms are three months, six months, one year, two years, three years, and five years.
- If you are looking to hedge against interest rate changes, and want access to a portion of your money every year, consider building a CD ladder.
Understanding CD Terms
When you take out a CD, you agree to leave your money in it for a set period of time, known as the CD's term. In exchange, the bank or credit union that issues your CD will pay you a set interest rate on your money, one that is typically higher than other types of savings accounts. The downside is that your money isn't liquid. If you need to take it out before the CD's term ends, you'll usually have to pay hefty penalties.
Each provider of CDs is free to set its own terms. Most CD terms range from three months to five years, although CDs with terms of less than three months, or 10 years and up, are also available. These are fairly standard lengths:
- Three months
- Six months
- One year
- Two years
- Three years
- Five years
When deciding which CD to choose, the term is an important consideration. If you are saving money in a CD in anticipation of a big purchase at some point in the future, or for a specific goal or project, that can help you determine your maximum CD term length. In contrast, if you're just socking away cash for which you don't have a specific purpose in mind, you might opt for a longer term so as to maximize your interest rate.
Alongside the typical terms, you might also see some CDs with unusual term lengths. In fact, some of the best CD rates can be for terms like five months, 17 months, or 21 months. That may be to stand out from the competition, to match a birthday the bank is celebrating, or any number of other reasons. So by looking beyond the conventional terms, you can sometimes find a better-paying opportunity.
Generally, the longer the term of your CD, the higher its interest rate will be. So you'll earn more with a five-year CD than with a one-year CD, for example. However, the longer the term, the greater the risk that you'll miss out if interest rates rise. One way to protect yourself is to build a CD ladder. It will allow you to earn the high-interest rates of long-term CDs on a portion of your investment while also giving you access to some of your money on regular basis.
Building a CD Ladder
There are two main considerations when choosing a CD term. One is how long you are willing to go without access to your money. The other is the current interest rate. If interest rates rise over the next few years and your money is locked away in a relatively long-term CD, you could miss out on the higher returns. In addition, your money could be losing purchasing power due to inflation. Unfortunately, interest rates are hard to predict.
It is possible to mitigate both of these risks by building a CD ladder. A ladder enables you to access the higher rates offered by five-year CDs, but with the twist that a portion of your money becomes available every year, rather than every five years. Here's an example of how to do it:
- Take the amount of money you want to invest in CDs and divide it by five.
- Put a fifth of the funds into a one-year CD, another fifth into a two-year CD, another into a three-year CD, and the rest into a four- and five-year CDs. Let's say you have $25,000 available. That would give you five CDs of varying terms, each with a value of $5,000.
- When the first CD matures in a year, you take the proceeds and open a new five-year CD.
- A year later, your initial two-year CD will mature, and you'll invest those funds into another five-year CD.
- You continue doing this every year with whichever CD is maturing.
Eventually, you’ll have a portfolio of five CDs all earning five-year APYs, but with one of them maturing every 12 months—making your money more accessible than if all of it were locked up for a full five years. You can make it even more readily accessible by adding three- or six-month CDs to the mix.
What Is the Shortest Term for a CD?
The shortest term for a CD that you'll commonly see is one month.
What Is the Longest Term for a CD?
These days, CDs with terms longer than 10 years are uncommon. Most mature in five years or less. CD issuers could offer longer maturities, but anyone looking to invest for the long haul is likely to prefer other investment products that generally provide a greater return over time, such as stocks and bonds.
What Is the Best CD Term?
It really depends on your circumstances. If you have a particular project or purchase in mind, put your money into a CD until then. If you are looking to earn the highest interest rates, put your money into a longer-term CD. But just make sure you won't need to withdraw it before the term is over, or you'll have to pay a penalty.
The Bottom Line
CDs are available in a range of terms, with three months to five years being the most common. The longer the term, the higher the interest rate your CD may earn, but the more you're likely to lose if you need to get your money out early. If you are looking to hedge against interest rate changes, and want access to a portion of your money every year (or sooner), you can build a ladder with CDs of different terms.