Should You Open a Long-Term or Short-Term CD?

Other than finding a good rate, the most important thing to consider when opening a new CD (certificate of deposit) is the maturity length. Do you want a short-term CD -- typically a 6-month CD or a 12-month CD -- or a long-term CD (three to five years)?

Both types have their ups and downs, so it really comes down to your own banking goals. In general, though, short-term CDs are probably best for most folks in most cases. Here's a look at why.

Pros of short-term CDs

There are two big reasons to go with a short-term CD.

1. Higher rates

The first, and arguably most important, reason to go with a short-term CD is the APY (annual percentage yield). The very best CD rates tend to be from short-term CDs.

For example, you can easily find a ton of 6-month and 12-month CDs with rates in the 5% range. However, you're going to have a hard time finding a 3-, 4-, or 5-year CD with a rate above 4.5%.

Now, for context, if you can get close to the above rates, you're doing pretty well no matter which way you go. The national average is 1.49% for 6-month CDs and 1.40% for 5-year CDs. That said, 5% is still better than 4.5% when it comes to making money.

2. Lower chance of penalty fees

The other big positive of a short-term CD is that your money isn't locked in for years. You see, CDs have very severe early withdrawal penalties that can equal up to half of your interest income.

If you think there's any chance you may need your money within the next few years, avoid a long-term CD. Even if you find a magical 3-year CD with a sky-high APY, chances are it won't be as profitable overall if you're stuck paying penalty fees because you need your money in year two.

In some cases, even a 6-month CD may be too long to tie up your money, such as with your emergency fund. In this case, stick with a high-yield savings account. You won't lose access to your money, and the rates right now are actually very comparable to even top CDs.

Cons of short-term CDs

The main downside to a short-term CD is that your rate will expire when your CD matures. If the market rate has decreased, the new rate could be lower than your previous rate.

For example, say you currently have a 12-month CD at 5%. If the Fed drops its rates during that year, most banks will likely follow suit. So when your CD matures, it will roll over into a new 12-month CD and will likely have a rate below 5%.

The primary reason to get a long-term CD: Rate lock

Your rate is locked in for the full life of your CD, so the most compelling reason to get a long-term CD is to lock in your interest rate for up to five years (60-month CDs are as long-term as you can get).

In other words, if you think interest rates are going to drop, then locking in the current high rates with a long-term CD could actually be a smart financial move. And considering that the Fed is forecasted to cut rates a few times in 2024, this wouldn't be a completely outlandish assumption to make.

But this does bring us back around to the fact that long-term CDs lock in your money as well as your rate. The early withdrawal penalties will likely make the higher rate moot if you need your money before the CD matures.

TL;DR: Shorter terms are better for most folks

To sum it up, short-term CDs are generally better because they tend to offer higher interest rates and your money isn't tied up for years and years. Long-term CDs can be good if you really want to lock in the current rate, but you have to be absolutely certain you won't need that money before the CD matures so you won't get hit with early withdrawal penalty fees.