5 Factors to Weigh When Choosing Your First CD

The impossible has happened -- certificates of deposit (CDs) have become, dare I say, sexy. This is thanks to a persistently higher federal funds rate than we've seen in a good long while. This number doesn't directly inform consumer interest rates, but they do tend to move in the same direction.

If you've caught the CD bug and are looking to open your first one, here are a few factors you should consider when you're picking the right account for your needs.

1. Online or traditional bank?

Let's get this out of the way right now: You are overwhelmingly more likely to find the best rates available on CDs offered by online-only banks. Online banks don't have the overhead costs of maintaining physical bank branches. Consequently, they tend to offer higher APYs on CDs, savings accounts, money market accounts, and sometimes also checking accounts.

Online banks have their pros and cons, and in the context of opening a CD, you may need to link an external bank account to an account at an online bank, to fund your CD. You won't be able to, say, go in person to open the account and deposit cash into it. That said, since CDs are more of a hands-off type of account, the best options being at online banks shouldn't be a deal breaker.

2. What term lengths are available?

You can find CD terms as short as seven days, and as long as 10 years. The most common options range from three months to five years, however. If you're hoping to benefit from higher rates on CDs now, you're likely to find the best CD rates on terms between six and 18 months. Now could be a great time to create a shorter-term CD ladder, in fact -- you could open multiple CDs with term lengths between three months and 18 months, and have money freeing up every few months.

This is because it's widely believed that the Federal Reserve will start cutting the federal funds rate later this year. Consequently, you won't see higher rates on, say, 5-year CDs -- banks don't want to pay out these rates for any longer than they have to.

3. Is there a minimum deposit required?

Whether you want to open one CD or several, you need to assess how much money you can afford to part with, because some banks have rather high minimum deposit requirements. Of course, the more you put into a CD, the more interest you stand to earn -- and you generally can't add more money to a CD over time. If you're just testing the waters, target a bank with no minimum required deposit, or a lower one (such as $500).

4. What's the early withdrawal penalty?

CDs can be a great way to safely earn interest on your cash, provided you can leave the money untouched for the duration of the term. If you can't, however, you'll have to pay an early withdrawal penalty. These are usually the equivalent of several months' (or longer) worth of interest earned on the account -- and if you haven't had the money in there long enough to earn that much, you'll end up with less principal than you started with.

This isn't ideal, so investigate those early withdrawal penalties from any bank you're considering, and be sure you can leave the money in the account for the full term.

5. Can you make more money elsewhere?

Finally, it would be remiss of me not to mention that if you want a risk-free way to grow your money, you are not limited to just CDs these days. You can earn APYs of 5.00% and up on savings accounts and money market accounts now, too -- and these accounts don't have the same restrictions as CDs.

High-yield savings accounts (HYSAs) are simple to use and while they often have monthly withdrawal limits, you can still access your money if you need it. Money market accounts (MMAs) also usually have those limits, but they make it even easier to get your money -- they often come with checks or debit cards. So before you decide for sure that a CD is what you want, consider these two options as well.

Just note the advantage of CDs over HYSAs and MMAs: with a CD, you're locking in the high rate you get for the duration of the term. Rates on HYSAs and MMAs are variable and subject to change at any time (and I'll be watching for this if the Federal Reserve cuts rates later this year as expected).

CDs can be a great way to grow your money over time, if you can cope with their restrictions and find the best rates and terms for you. Consider these factors when you're doing your research.