5 criteria for selecting a CD term

Putting money into a certificate of deposit (CD) is a commitment. A CD is an agreement to leave your money in the bank for a specified period of time--the term--in return for a fixed rate of interest.

Typically, interest rates on CDs rise as the term of the CD gets longer. However, you shouldn't just blindly choose the highest interest rate you see, even if you are financially able to commit to a term of several years or more.

5 criteria that should affect your choice of CD term

What should you consider in choosing the length of your CD commitment?

1. When you will need the money. The primary factor should be how long you could lock up your money, putting aside for now whether it's best to do so. When do you incur major expenses that will mean tapping into those funds? How sure are you about the timeline? Will you need all the money at once, or could a portion do? If you will need to access the money in stages, or if there is a chance you will need to draw on some of the account unexpectedly, you might consider CDs of varying lengths in a CD ladder, or splitting those savings between CDs and more accessible accounts such as savings accounts or money market accounts.
2. The reward for commitment. Once you have a target term in mind, look at interest rates on CDs of that term across banks to determine how well you would be rewarded for committing your money for that length of time. If you're focusing on shorter-term CDs, compare those CD rates with savings account rates or money market rates, which would require no commitment. You want to make sure that you are getting enough additional interest to compensate you for your commitment.
3. The price of breaking your commitment. Know the penalty for early withdrawal of your CD. If it is severe, you need to think through the consequences of breaking your commitment--is it still worth it to you to enter into this agreement, given the chance you may have to make an early withdrawal? If the early withdrawal penalty is mild, consider whether the extra rate on an even longer CD would compensate you for paying that penalty if need be. For instance, if you could solidly commit to a 12-month CD, but the bank has a low penalty for early withdrawal, it could be worth it to stretch out to an 18-month CD and take the gamble, assuming the 18-month horizon still fits with when you need the money.
4. The outlook for bank rates. Before you lock into a CD for any length of time, think about what bank rates are likely to do over the term of that CD. If bank rates are unusually low, you might want to lean towards shorter CD terms to preserve flexibility. If bank rates are high, you might lean towards longer CD terms to lock in the rate. Inflation is also a consideration--the more concerned you are with rising inflation, the shorter you should keep your CD terms.
5. Where to find the best CD rates. Once you've determined the general parameters of what you need from a CD, compare CD rates to make sure you are getting the best deal available. New offers on CD rates can change quickly, so even after you've done your preliminary research, it might pay to double-check the latest rates before you commit.

Keeping these things in mind will help you find the CD that is the best fit for you--and avoid the trap of a CD term that's too long or too short.