3-Month CD Rates Are Up to 5.5%. Should You Open One Now?

Certificates of deposit (CDs), while never the most thrilling investment you could have, have lately given savers a ride for their money.

For the first time in over a generation, the best CD rates are above an APY of 5.00%. That's a guaranteed rate of return, as long as you keep your money locked up for the length of your CD term.

The most lucrative offers are on the shorter terms, like 3-month CDs. In fact, if you look on the financial platform Raisin -- which lists numerous high-yield CDs from a variety of banks and credit unions -- the highest yielding CDs both have 3-month terms. One, a Western Alliance Bank CD (APY of 5.26%). The other, a Ponce Bank High-Yield CD from Raisin (5.20%).

A 3-month CD isn't a huge investment. After all, you won't have to wait long before your CD's maturity date, after which you have penalty-free access to your money. But there's another reason you might want to lock into a 3-month CD. And that has to do with the likelihood that these outstanding rates won't be around much longer.

Why you might want to lock into a 5.50% 3-month CD

Without doubt, CD rates will fluctuate in 2024. The question is when -- and by how many percentage points.

To understand why, recall that our high rate environment is supported by the Federal Reserve's mission to cool inflation. With the final chapter on that campaign being written, it now appears the central bank will reverse course and start hiking rates down. Doing so would lead to a rate reduction on CD terms, most likely starting with those that boast the highest APYs.

In fact, 3-month CD rates have already started to retreat. Just take a look for yourself. The following is how the yield for 90-day CD changed in 2023, according to data from the Organization for Economic Co-operation and Development.

To be sure, the Federal Reserve hasn't signaled any rate reductions just yet. But if this trend continues, fewer and fewer banks will likely offer 5.50% APYs on CDs, no matter the term.

Why you should be cautious about 3-month CDs

A 3-month CD is great for money you won't need for the near term. But it doesn't offer the same flexibility as a savings account, nor does it guarantee a high rate for a long period of time.

Most 3-month CDs have early withdrawal penalties to discourage you from pulling out too soon. These penalties typically equal a certain amount of interest lost, whether earned or not. For example, a 3-month Western Alliance Bank CD offered through Raisin has an early withdrawal penalty of 90 days. That means, you would lose money if you withdraw from this CD at any point before maturity.

Another thing to consider is that APY is annualized. Depositing $10,000 into a CD with a 5.50% APY would leave you with an extra $550 after 12 months. Assuming you choose a 3-month term, you would earn about $137.50. That's not bad for 90 days. But if you lock into a 3-month CD thinking your earnings will equal 5.50% of your deposit, you'll be disappointed.

Finally, CD earnings are considered taxable income, both on federal and state levels. This makes 3-month CDs less lucrative than 3-month Treasury bills, which have similar rates to CDs but are exempt from state taxes.

If none of these faze you, then don't hesitate to make your decision. By the looks of it, the final call for this cycle of high CD rates may have already sounded out. While the Federal Reserve may pause rates, it likely won't raise them any higher. Take a look for yourself at today's top-paying CDs and see if it's worth locking up a portion of your savings in exchange for a high APY.