There are benefits and drawbacks to putting money into a certificate of deposit (CD). On the plus side, you'll often be looking at a higher interest rate on a CD than a savings account. And also, the interest rate on your savings account can change from week to week. But when you lock in a CD, you're guaranteed to continue receiving the rate you signed up at for the length of your CD's term.
Of course, the downside of putting money into a CD is that you'll be penalized for withdrawing your money early. The exact penalty will depend on your bank, but three months of interest is a common penalty for cashing out a 12-month CD before it comes due. And also, when you put money into a CD, you commit to that day's rate. But if rates rise a week or so later, you're stuck, whereas with a savings account, your interest rate simply adjusts upward.
If you have money you don't need for near-term goals or emergency expenses, then now's actually a good time to start thinking about opening a long-term CD -- say, one with a 48- or 60-month term. And there's a big reason why.
Lock in that rate before interest rates fall
The main reason CDs are paying so generously right now is that the Federal Reserve has raised interest rates numerous times since early 2022 to cool inflation. Of course, an unwanted side effect of those rate hikes is higher borrowing rates for loans and credit cards. But savers at least get to benefit.
At this point, though, it looks as if the Fed is done raising interest rates. In fact, the central bank actually opted to pause its interest rate hikes at its last three meetings. And the Fed has also indicated that it may be looking at cutting rates at some point in 2024.
That would be a good thing for consumers, many of whom are buckling under the weight of expensive credit card and loan interest rates. But it could also lead to lower CD rates, as well as lower interest rates in savings accounts.
That's why you may want to open a longer-term CD in the coming weeks. Once the Fed cuts rates, CD rates are apt to fall. If you open a long-term CD soon, you can lock in a generous rate for many years.
Remember, it's possible that in two or three years from now, CDs will be paying 2.5% interest at best. So if you can lock in a 5-year CD at 5% now, that means that once things reach that point, you'll continue to earn more interest on your money while savers opening new CDs will be signing up to earn much less.
Can you afford to part with the money?
It's one thing to lock some cash away in a 1-year CD. A 5-year CD is a much bigger commitment.
Before you open one, ask yourself:
- Am I happy with my emergency fund, or should I boost it?
- Do I have near-term goals I might need cash for?
- Will I have big expenses to pay for in three or four years, like college tuition or a new car?
If you're confident you can afford to tie up your money for a lengthy period of time, then now's a really good time to open a long-term CD. But if you're not sure you won't need that money, then you're better off sticking to a shorter-term CD, or even just keeping your money in a regular savings account.
