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You can earn higher interest rates with a CD than a traditional savings account—here's how they work

CNBC Select explains how a certificate of deposit works.

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Select’s editorial team works independently to review financial products and write articles we think our readers will find useful. We may receive a commission when you click on links for products from our affiliate partners.

Like traditional and high-yield savings accounts, certificates of deposit — commonly referred to as CDs — are another type of account that banks and credit unions offer to customers who want to set aside and grow their money.

But while some CDs can come with higher APYs, there are also a lot more rules that account holders must follow in order to earn the highest rates, avoid fees and get the most out of these accounts. These requirements vary depending on the financial institution, so it's important to make sure you read the fine print before you open a CD.

How CDs work

When you put your money in a CD, you earn a fixed interest rate for a specific amount of time on the money you deposit when you open an account. Term lengths range between three months and five years, and usually the longer the term, the higher the APY. Typically, you can't access your money before your term ends, or you'll get hit with an early withdrawal penalty. The penalty fees can vary depending on your bank and your CD's term length, but it's usually the interest earned, or the interest that you would have earned, over a certain number of days or months.

On the date the CD matures, or when the term length is over, savers can get their money back, in addition to the interest earned over time.

Unlike high-yield savings accounts, which have variable APYs, you're locked into the interest rate on a CD the day you open the account. This can be a good thing if you open an account before the rate drops, which is what has happened recently when the Fed slashed interest rates in response to the economic fallout from the coronavirus pandemic.

Savers who open a CD only make the one-time deposit upfront, and they can't make additional contributions during the term. CDs typically don't come with monthly fees and are federally insured so your money is protected, which makes them one of the safest investment vehicles.

When to open a CD

Setting money aside in a savings account can help you plan for big financial milestone purchases, such as a new car or the down payment on your first home. But even though that money is earmarked for something important, you know you can always tap into if you need to. For people who are disciplined, this isn't a big deal. But if you need more of an incentive not to touch your savings, a CD can be a smart move.

Opening a CD is also a good idea if you're saving up for large purchases because you can rest assured that your money will grow, and there's no risk or volatility like there is when you put your money in the market.

Because you can be penalized for early withdrawals with a CD, you'll be less tempted to tap into your savings. But this also means it's not a great account to use for your emergency fund, where you need easier access to your cash.

Instead, you're better off going with a high yield savings account for any money you might need to tap soon. CNBC Select ranked the top high-yield savings accounts, and the best overall for straightforward, no fees whatsoever and easy mobile access is the Marcus by Goldman Sachs High Yield Online Savings.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.