Ask Yourself These 3 Questions Before Tying Up Money in a CD

They're important ones to contemplate.

You've probably noticed that banks are offering higher interest rates for products like savings accounts and CDs these days. That gives you a prime opportunity to score a great return on your money in a pretty low-risk fashion.

When you invest money in assets like stocks and crypto, you risk losing principal. With a savings account or CD, your principal of up to $250,000 is protected provided you're at an FDIC-insured bank.

Meanwhile, when you put money into a savings account, your interest rate can change pretty frequently. With a CD, you're guaranteed the same interest rate for a preset period of time. And often, that interest rate will be higher than what a savings account is willing to pay you.

That said, with a CD, you must commit to keeping your money in place for a certain amount of time, whether it's 12 months, 24 months, or a different time frame. So before you make that commitment, ask yourself these important questions.

1. Do I need this money for emergency bills?

You should, ideally, have at least three months' worth of living expenses on hand as your emergency fund. And that money should not sit in a CD.

The reason? You need to be able to tap your emergency fund on a whim, and CDs don't allow for that. Make sure you're not tying up emergency cash, and only open a CD with money you're not earmarking for sudden unplanned bills.

2. Do I expect to use this money within the next seven years?

As a general rule, you shouldn't invest money you expect to use or need within seven years, the reason being that if the market suffers an extended slump, you may not have a long enough investing window to recover from losses in your portfolio. But if you have a pile of cash you want to earn a return on that you don't expect to use within seven years, then you may be better off investing it in a brokerage account instead of putting it into a CD.

When you go the investment route, you take on more risk. But you might also snag double the return compared to what a CD will pay you -- even at today's higher rates.

3. Do I know the penalty for cashing out my CD early?

Cashing out a CD before it comes due will commonly result in a penalty. It's important to know what that looks like before tying up your money.

Now, there aren't universal rules when it comes to CD penalties. Rather, each bank sets its own. But as an example, one well-known bank penalizes savers who cash out a 12-month CD early with three months' worth of interest withheld or deducted from their balances. It's important to know what penalty you might face so you fully understand the risks involved.

Opening a CD isn't a poor choice right now per se, especially with rates being higher. Just make sure to run through these important points before taking the plunge.