Fixed-Rate Certificate of Deposit (CD) Definition

What Is a Fixed-Rate Certificate of Deposit (CD)?

A fixed-rate certificate of deposit (CD) is a type of savings account with a set interest rate over its entire term. CDs generally offer terms in increments of 3 months up to 1 year and then switch to 2-, 3-, and 5-year terms, during which your money remains untouched in the account. There are also CDs with 10-year terms.

In general, the longer the term of the fixed-rate CD, the higher the fixed interest rate, although exceptions exist. You can buy CDs online or in person from a bank or credit union.

Key Takeaways

  • A fixed-rate certificate of deposit (CD) is a type of savings account that locks up your money with a set interest rate for a set term.
  • Upon maturity of a CD, holders can either withdraw the entire amount or roll it over into another CD.
  • Typically, longer-term fixed-rate CDs pay higher interest rates, unless the financial institution offers a promotional rate for shorter terms
  • If you withdraw funds from a fixed-rate CD early, you'll likely pay several months of interest as a penalty.

Understanding a Fixed-Rate CD

Savers who are conservative with their investments may be attracted to fixed-rate CDs, which provide steady income streams until maturity. Furthermore, because CDs are guaranteed by the Federal Deposit Insurance Corp. (FDIC) up to $250,000 (per account holder, per issuer), investors placing money in CDs feel comfortable about their asset's safety. Fixed-rate CDs may not pay as much interest as other fixed income securities, but conservative savers accept the tradeoff of lower interest for lower risk.

However, as with any interest-earning investment, investors do encounter inflation risk. This occurs when the inflation rate exceeds the investment's interest rate and erodes your future purchasing power.

You can choose various terms for your CD that typically range between a month and several years. During this time, you leave your money in the CD account until the maturity date, or the date the term ends. At the maturity date, you can remove your original deposit plus interest earnings or roll over the amount and interest into a new CD.

Some banks or credit unions offer promotional rates for specific lengths of time, such as 3 months or 11 months. These rates may pay a higher interest rate than other terms. You may also be able to find high-yield CDs with higher rates.

Banks typically charge a penalty for early withdrawal of funds from a CD, so it's usually best to leave the money in the instrument until it matures. Upon maturity, depending on your financial needs, you may roll over the matured CD into another one. The new fixed rate for the CD, however, is likely to be different from the CD that just matured.

Fixed-Rate CD vs. Variable-Rate CD

A variable-rate CD has a fixed term like a fixed-rate CD, but the CD's interest rates can fluctuate. Some CDs may include one or two options to raise your rate during the term, which tends to be longer with fewer options than a fixed-rate CD.

For example, you may only be able to choose between a 2- or 4-year term and the ability to raise your rate only once. These CDs may be called rate bump CDs, bump-up CDs, or another term exclusive to the bank or credit union. Other variable CDs are tied to a certain index, such as the prime rate index.

An investor in a variable-rate CD is less risk-averse than a fixed-rate CD buyer and may believe that interest rates will rise over the time the CD locks up cash. If correct, the CD will generate more interest than a fixed-rate CD.

CD holders must pay federal taxes on the interest they earn at their tax bracket rate.

Example of a Fixed-Rate CD

A bank offers a fixed-rate CD that guarantees interest rate returns of 5%. The CD’s term period is 6 months. Tatiana invests $1,000 in the CD. After 6 months, she has earned about $25 (the exact amount depends on how often the interest is compounded). She can withdraw the $1,025 or roll it over into another CD. She chooses the latter option and, at the end of a year, withdraws about $1,050 upon its maturity. She will owe taxes on her $50 earnings.

In contrast, Tatiana’s friend Marc also invested $1,000, but in a variable or bump-up 24-month CD. If rates rise to 6% or more in the next 12 months, Marc will make a little more than Tatiana by the first year's end.

Should I put my money in a certificate of deposit (CD) during a recession?

During a recession, people want the safest options for their investments. Fixed-rate certificates of deposit (CDs) are a secure option because they are insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000. Keep in mind that funds put into a CD will not be easily liquidated without withdrawal fees, until the time of the CD’s maturity. However, if the inflation rate is greater than the interest rate, the difference could lower your overall returns.

Will I earn more with a fixed-rate CD or a liquid CD?

A fixed-rate CD typically offers a higher rate than a liquid CD, also known as a penalty-free CD. A liquid CD allows you to withdraw your funds early without paying a penalty. You may earn more total interest with a fixed-rate CD than with a liquid CD if you leave your money invested longer. This assumes overall interest rates don't go up and cause you to miss out on potentially better investments. If rates rapidly increase, a liquid CD could earn more over time if you remove your money and reinvest it in a higher-rate CD. In addition, if you need your money earlier than you anticipated, you can withdraw without paying a penalty.

Is there a penalty if I withdraw my money from a fixed-rate CD?

Yes, there is a penalty for withdrawing money from a fixed-rate CD before maturity. If worried you might need your money before the maturity date, consider a CD ladder. This investment strategy ensures that you will get some of your money back at different time periods, hopefully avoiding any early withdrawals.

The Bottom Line

A fixed-rate CD allows your money to grow in a low-risk vehicle as long as you keep your money in the CD for the entire term. Fixed-rate CDs can pay a consistent and higher interest rate than other types of CDs, with the rate being based on the term length. Compare fixed-rate CD options different financial institutions offer and the term lengths to find the best rate. Remember that if you withdraw your money before the maturity date, you'll likely pay a penalty of several months' interest. If you're new to CDs, you might start with a shorter term (such as a 3-month CD), a CD ladder, or a liquid or penalty-free CD.

Article Sources
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  2. U.S. Securities and Exchange Commission. "High-Yield CDs: Protect Your Money by Checking the Fine Print."

  3. CFPB. "The Interest Rate Offered for CDs (Certificates of Deposit) is Low. Is There Anything I Can Do About That?"

  4. HelpWithMyBank.gov, U.S. Office of the Comptroller of the Currency. “What Are the Penalties for Withdrawing Money Early from a Certificate of Deposit (CD)?

  5. U.S. Securities and Exchange Commission. "Variable-Rate CDs."

  6. Internal Revenue Service. "Topic No. 403 Interest Received."