Here's Why I Don't Own a CD Even Though Rates Are Sky-High Right Now

Certificates of deposit (CDs) have rarely looked so tempting, with many of the top banks offering interest rates around 5% with terms of just 12 months. But you won't find me parking any of my cash here, at least not for the foreseeable future. These accounts are a little too restrictive for me.

That doesn't mean CDs are a poor choice for everyone, though. To make the right call for yourself, you have to understand exactly what you're getting when you sign up for a CD.

How does a CD work?

CDs pay an interest rate that can be comparable to or even higher than a bank's savings account interest rates, but that comes at a price. To claim this rate, you must agree to leave your money alone for a length of time known as the CD term. This depends on the CD you choose. Short-term CD terms might only be a few weeks or months, while long-term CDs can have terms of five years or more.

It's possible to take your money out before a CD term ends, but you'll usually pay an early withdrawal penalty equal to several months of interest payments. This could even cost you some of your principal if you take your cash out shortly after opening the CD. You also can't make partial withdrawals. You must take all your cash out of the CD at once.

These limitations make CDs a poor choice for housing your emergency fund or any cash you hope to spend within the next few years. If you're worried about early withdrawal penalties, a high-yield savings account is a better choice for you.

I choose to keep my savings in one of these because I can still earn a high rate of interest on my funds, and I can make withdrawals whenever I need to. Currently, many of the best savings accounts also have interest rates close to 5%, so I can earn a similar amount to what the best CDs offer.

But one drawback of savings accounts is that they don't have locked-in interest rates. When rates begin falling, as they're expected to later this year, savings account interest rates will fall while CD rates remain locked in at the rate the bank offered when you opened it.

Who is a CD good for?

A CD could be a better fit for you than a savings account if you're worried about losing money due to falling interest rates. By securing a high CD rate now, you can be assured that you'll earn an above-average rate for the next few months or even several years. 

If you're worried about losing access to your cash, you could always try building a CD ladder. This is where you divide your money equally between CDs of different term lengths -- for example, a 1-year CD, a 2-year CD, a 3-year CD, etc. When one CD term ends, you can either spend that money or invest it in another long-term CD. This gives you access to some of your money every year and enables you to take advantage of the higher rates long-term CDs generally offer.

CDs could also be a good fit for those who want to get better at saving but worry they might be tempted to spend their funds if they're left in a savings account. The CD's early withdrawal penalty might be just the motivation you need to leave that cash alone for a while.

It doesn't hurt to compare some top CD offers with some of the best savings account interest rates to see which appeals to you more. Be sure to dive into each account's fees as well so you know what the bank can charge you for and how much you'll pay. And if you have any questions, reach out to the bank for clarification before you open the account.