When I was younger, I never understood the appeal of certificates of deposit. You put your money in a lockbox, you get a tiny little interest rate, and then after a year or two or five, you get a little bit more than you put in.
As I've gotten older, I've realized that there's value in principal protected, interest-bearing accounts. High yield savings accounts are the best and CDs are a close second if you don't need the cash for a minute. CDs are great because it's principal protected, FDIC insured, and completely safe.
Once I did a little more digging, there's more to a Certificate of Deposit than its interest rate.
How to Find a Good CD
The math behind Certificates of Deposit is simple to understand.
The longer the CD, the higher the interest rate.
Brick and mortar banks just aren't able to offer the same interest rates as online banks.
So go with as long of a CD as you can with an online bank. Boom, done.
Here's a typical schedule from an online bank, as of May 29th, 2019:
|Term||Annual Percentage Yield (APY)|
|3 Month CD||0.35%|
|6 Month CD||0.65%|
|9 Month CD||0.70%|
|12 Month CD||2.65%|
|18 Month CD||2.65%|
|36 Month CD||2.70%|
|60 Month CD||3.00%|
|120 Month CD||3.10%|
As you can see, the longer the term, the greater the interest rate.
Here's a similar schedule from a brick and mortar bank, as of March 2019:
|Term||Annual Percentage Yield (APY)|
|3 Month CD||0.03%|
|6 Month CD||0.03%|
|9 Month CD||0.03%|
|12 Month CD||0.05%|
|18 Month CD||0.07%|
|24 Month CD||0.10%|
|30 Month CD||0.10%|
|36 Month CD||0.55%|
|48 Month CD||0.65%|
|60 Month CD||0.75%|
|120 Month CD||0.75%|
Brick and mortar banks often can't hold a candle to online banks.
Minimum Deposits & Interest Rate Tiers
Online banks almost always a minimum deposit of $1 and the interest rate applies to small CDs as well as larger ones. Some online banks will have tiers but the lowest ones are typically very good anyway.
Brick and mortar banks will change the interest rate based on how much you deposit. The tiers are often in the thousands of dollars to get better interest rates.
For example, here are the interest rate tiers for a 60-month CD (Feb 2018):
- $0 – $9,999.99 – 0.60% APY
- $10K – $24,999.99 – 0.80% APY
- $25K – $49,999.99 – 0.80% APY
- $50K – $99,999.99 – 0.80% APY
- $100K – $249,999.99 – 0.85% APY
- $250K+ – 0.85% APY
Capital One 360 has a 60-Month CD with a 2.65% APY, no minimums to get that highest tier.
A 36-month CD at Ally Bank is an example of an online bank with tiers (March 2018):
- $0 – $4,999.99 – 2.6% APY
- $5K – $24,999.99 – 2.70% APY
- $25K – $49,999.99 – 2.75% APY
Early Withdrawal Penalty
There is one feature that often differs between banks, other than interest rates – the early withdrawal penalty.
You'd think that there wouldn't be many variations among banks on the early withdrawal penalty – but there is.
The early withdrawal penalty is assessed if you close your CD before its maturity date. You always have the option to withdraw your funds and close the entire CD, you simply surrender some or all of your accrued interest.
The penalty varies based on the length of the CD.
Ally Bank has the lowest early withdrawal penalties:
- 24 months or less: 60 days of interest
- 25 months – 36 months: 90 days of interest
- 37 months – 48 months: 120 days of interest
- 49 months or longer: 150 days of interest
Discover Bank has a more typical early withdrawal penalty schedule at online banks:
- 11 months or less: 3 months of interest
- 1 year to < 4 years: 6 months of interest
- 4 years to < 5 years: 9 months of interest
- 5 years to < 7 years: 18 months of interest
- 7 to 10 years: 24 months of interest
Here's a brick and mortar schedule, from Bank of America:
- 90 days or less: greater of all interest earned or 7 days of interest
- 90 days up to 12 months: 90 days of interest
- 12 months – 60 months: 180 days of interest
- 60 months or longer: 365 days of interest
Different CD Types
Up until now, you've seen the most basic CD – you deposit a sum, it accrues interest until maturity, then you get it all back.
There are banks with CDs that have extra features.
Ally Bank has led the way with the variety of CDs they offer:
- High Yield CD – This is their name for the standard CD.
- Select CD – This CD changes from time to time but will be an oddball term with a promotional rate. At the moment, it is a 2.15% APY 30-Month Select CD that automatically renews into an 18-Month High Yield CD when it matures. Ally doesn't otherwise offer a 30-Month maturity.
- Raise Your Rate CD – If you dislike CD rates going up when you're locked in, this 24-month or 48-month CD has a competitive interest rate that can bump up (once for a 2-year, twice for a 4-year) if the rate increases.
- No Penalty CD – This CD has no early withdrawal penalty, but it's usually an odd maturity (now 11 months) and a slightly lower interest rate.
If it feels like Ally Bank gets a lot of love in this post, it's because I use them and they have some of the most innovative deposit products in the CD space.
One of those innovations is what's known as a “Loyalty Reward.”
If you renew a CD at Ally Bank, they give your interest rate a little bump. As of February 2018, that bump is only 0.05% APY:
Hi Jim, we currently offer a .05% Loyalty Reward for CD renewal, and will keep the community updated on any future offerings as they become available. Please let us know if we can answer any further questions! ^KM
— Ally (@Ally) February 22, 2018
When you renew, you take whatever the prevailing interest rate and add 0.05% APY. In previous years, when interest rates were higher, I saw Loyalty Rewards as high as 0.50% APY.
You now have a solid understanding of the lay of the land when it comes to certificates of deposit!