Certificates of deposit (CDs) are designed to help savers grow their money over a set time period. The money in a CD earns interest until it's withdrawn at maturity or rolled over to a new CD account. When buying CDs, it's important to consider the timing and how that might affect the interest rate you could earn.

How CDs Work

Certificates of deposit are time deposit accounts. Unlike regular savings accounts, which allow you to add and withdraw money as needed, CDs typically let you make an initial deposit and then withdraw your money later, when the account matures. While the money is in your CD, it can earn interest. The interest rate and annual percentage yield (APY) for a CD are usually tied to the term.

CD terms can be as short as 28 or 30 days or last as long as 10 years. A longer CD term typically corresponds to a higher interest rate and APY, while shorter maturity terms usually carry lower interest rates. When choosing CD terms, it's important to consider how soon you'll need the money to avoid the possibility of having to pay an early withdrawal penalty.

A CD early withdrawal penalty is a fee banks can charge when you take money out of your account before maturity. Depending on the bank's policy, the penalty might be a flat fee or some or all of the interest earned.

Overall, CDs are considered to be some of the safest places to save because there's very little risk of losing money. You're also protected by FDIC coverage. The Federal Deposit Insurance Corp. insures deposit accounts at member banks in the event of a bank failure. The current FDIC coverage limit is $250,000 per depositor, per account ownership type, per financial institution.

When Is the Best Time to Buy a CD?

The best time to buy a CD is when interest rates are high or you have a specific savings goal that would be suited to a CD. The higher the interest rate on a CD, the more your money can grow during the maturity term. When rates are low, you earn less interest.

So how do CD rates work? The simple answer is that banks typically set them based on movements in a benchmark rate. For many banks, the federal funds rate serves as the benchmark. This is the rate at which banks lend money to one another overnight.

The Federal Reserve makes adjustments to the federal funds rate in order to direct monetary policy. For example, if inflation is increasing at a rapid pace or the economy is growing too quickly, the Fed may raise the federal funds rate. This is intended to have a "cooling" effect because it discourages consumers from borrowing money or spending excessively.

On the other hand, if the economy is sluggish because of a recession and a decline in consumer spending, the Fed may lower interest rates. This makes borrowing less expensive and, in turn, can encourage consumers to take out loans and spend.

The federal funds rate doesn't directly affect CD rates or rates for other savings accounts. But banks can use changes in the federal funds rate to decide how to price deposit accounts and set interest rates for loans.

How To Make the Most of CD Rates

Savers have no control over what happens with CD rates, unfortunately. But there are some things you can do to maximize interest earnings with CDs in a changing rate environment. One option is to consider CDs that offer you a higher rate if rates go up during your maturity term. These CDs can go by different names, including:

• Bump-up CDs
• Step-up CDs
• Raise Your Rate CDs

If you open one of these CD accounts and interest rates rise afterward, you may be eligible to increase your rate once or twice during the maturity term. The bank may make a rate adjustment for you automatically or allow you to request a rate increase. The advantage of this type of CD is that you can earn more interest if rates change during your maturity term. The downside is that banks may offer a lower rate initially for these CDs, so if rates don't increase, then you won't have a chance to bump or step up your rate. You also could consider a no-penalty CD. This type of CD allows you to withdraw money before maturity without paying an early withdrawal penalty. If you have this kind of CD and rates go up, you could pull your money out and use it to open a new CD at a higher rate without being penalized.

Finally, you could build a CD ladder. A CD laddering strategy involves opening multiple CDs with different interest rates and maturity terms. By staggering maturities, you can decide whether it makes sense to roll funds over into a new CD or to withdraw them based on what's happening with CD rates.

The Bottom Line

The best time to buy a CD for most people is when they're able to get the highest interest rate. But you may consider opening a CD account anytime you want to save money for an extended period and won't need to withdraw it before maturity. When researching banks to open a CD, start by comparing the best CD rates. Then consider what maturity term might be best for reaching your savings goals.