Certificates of deposit (CDs) are usually some of the highest-paying options available at banks and credit unions, but interest rates plummeted as a result of the COVID-19 pandemic, leaving CD investors with few attractive options.
So, what should you do with your savings? Does it make sense to lock in a rate at today's levels? You may want to maximize your interest earnings, but going all-in on long-term CDs right now could backfire.
By understanding today’s interest-rate environment and the drivers behind it, you can evaluate the alternatives and pick a strategy that makes sense. You may end up trying variations on classic CDs, going with different bank products, or just dealing with low rates until the economy heats up again.
How Banks Make Money
Banks and credit unions make money by gathering deposits from customers and lending that money. When you deposit funds into a savings account or CD, you might earn 1% APY or less on your balance, but banks lend that money to borrowers at higher interest rates. The difference between the amount banks pay and the amount they charge results in profits.
As of December 30, 2021, the average rate for a 30-year fixed-rate mortgage is 3.11% (plus potential processing fees or points). The average credit card rate is 20.45%, according to our database of credit card rates. Banks can also earn extra from annual fees and additional charges for late payments. The difference between those numbers, also known as the “spread,” shows you how much banks can earn.
Banks can also earn revenue from other sources. They might charge monthly service fees for accounts, offer premium services to business customers, and collect revenue if you pay overdraft charges or purchase cashier's checks.
Where Do CDs Come In?
A CD is a time deposit, because you agree to leave funds with the bank for a specific length of time. If you need to withdraw funds before your CD matures, you typically pay an early-withdrawal penalty, which encourages you to leave funds untouched and generates revenue for the bank.
Most importantly for banks, CDs are deposit accounts. The money you place in a CD provides funds that banks can “invest” by lending to other customers.
CD Rates in a Normal Market
During more normal times, CDs are relatively straightforward: Short-term CDs tend to pay a bit more than savings accounts, and your earnings increase as you select longer terms. By giving up flexibility, the bank rewards you with increasingly higher rates. For funds you don’t need for several years, a three- or five-year CD would typically provide a substantially better return than money that’s liquid in a savings account.
As interest rates change, CD rates tend to move in sympathy, although not always in lockstep. For example, when the Federal Reserve raises the federal funds rate, CD rates are likely to creep up. When the Fed cuts rates, savers should expect rate cuts. But other factors, such as economic activity or a bank’s appetite for new deposits, can also affect how much banks pay on CDs.
For example, if a bank anticipates a high demand for loans, the bank might offer an especially attractive rate on CDs to gather deposits. That’s exactly what Cross River Bank did in April 2020 when it advertised remarkably high rates online. Deposits came flooding in, and the bank was able to fund a large number of PPP loans for struggling small businesses.
In general, smaller financial institutions offer higher deposit rates than large banks, and they’re quicker to raise rates. There may be several reasons for this, including the fact that big banks rely on their megabank statuses (with an extensive branch footprint and the overhead that comes with it) to attract customers. Plus, with smaller institutions, it’s easier to move the needle with fewer dollars. Cross River Bank’s move in April put it in a position to become a leading PPP loan processor—and to substantially increase its revenue. Meanwhile, big banks such as Wells Fargo also earned fees from funding PPP loans, but may simply donate the fees generated.
CD Rates During the Pandemic
In March 2020, the Fed slashed the federal funds rate to a target range of 0% to 0.25% in an effort to support economic growth. Shortly after that, CD rates dropped precipitously, leaving savers with few attractive options for safe, long-term deposits.
In a statement on March 15, 2020, the Fed said: “The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”
Put another way, rates will remain low until the economy recovers. The federal government took additional steps to stimulate the economy. Still, only time will tell how effective those moves are, and it may ultimately depend on when various viruses are under control. Efforts so far include:
- Direct stimulus payments to taxpayers
- Enhanced unemployment benefits
- Small business relief loans and grants
The Balance continually monitors CD rates nationwide, and it's seeing lower rates across the board. That said, shopping around is still worth it, as some banks are competing for deposits, and you can make the most of a difficult situation.
What’s Ahead for CD Rates?
It’s wise to expect rates to remain low for a while. With an uncertain future, you need to be especially smart about earning interest on your cash going forward.
Try a Ladder
If you’re sold on CDs, a CD laddering strategy may be helpful. With that approach, you put money into a variety of different CDs with maturities spread out over time. Since you can’t know when rates will rise, you avoid locking up all your money in the wrong CD. You’ll own long-term CDs, which are beneficial if rates stay low; and you’ll own short-term CDs, which provide liquidity and allow you to reinvest at higher rates if rates rise sooner than expected.
Consider Liquid CDs
CDs that allow you to withdraw funds at any time could also make sense. You might want to lock in a rate now—just in case banks decide to cut rates even further. But if you need that cash, or if rates rise and you find a better CD, you have access to your money without worrying about early-withdrawal penalties.
Some banks may still want to compete for deposits, so it’s worth shopping around if you need to invest in a CD. The Balance keeps a list of the best CD rates available nationwide (updated daily), so you can easily focus your search on the highest-paying banks.
CD rates may be abysmal, but that doesn’t mean you can’t earn interest at your bank or credit union. Other types of accounts may still offer attractive rates. Interest checking (or “rewards checking”) accounts, in particular, pay remarkably high rates if you meet certain criteria. Those accounts may limit the amount of interest you can earn, but the high rates may make it worthwhile.