Which Is Better: A Short-Term CD or a Long-Term CD?

Certificates of deposit (CDs) can be an excellent place to store your savings. They often offer higher returns than standard savings accounts without stock market risk.

CDs are unique from other savings tools in that they have set terms, and when you deposit your money, you agree to keep it locked up for that amount of time. CD terms generally range from as little as a few months (or less, in some cases) to several years. The term you choose directly impacts the amount of interest you can earn.

To help you choose the best CD term, we’ll compare the features, advantages, and disadvantages of short-term and long-term CDs and discuss the factors to consider when choosing the right option.

Comparing Interest in Short- and Long-Term CDs

Here’s a table comparing the potential interest earnings of short-term and long-term CDs, assuming different deposit amounts and interest rates.

What Is a Short-Term CD?

A short-term CD is one that has a duration of one year or less. These CDs often have terms as short as three months, but some select banks may offer terms of just days or weeks.

Because of their short terms, these CDs don’t require you to lock up your money for long, meaning they’re a great option for short-term savings goals. They also often have lower penalties if you withdraw your money earlier.

Short-term CDs may also be ideal when you’re anticipating rising interest rates since they’ll allow you to take advantage of those higher rates more quickly.

What Is a Long-Term CD?

A long-term CD is one with a term of more than one year. Depending on your bank, these CDs may have maximum terms of anywhere from three to five years.

Long-term CDs require you to lock up your money for far longer, meaning they aren’t suitable for short-term goals. Instead, you should save them for money you don’t anticipate touching for at least a year. For example, a long-term CD may be a good option if you’re saving for a house but know you won’t be able to buy one for a while.

Long-term CDs sometimes pay higher interest rates and have the benefit of guaranteed returns, but they also have some risks, including interest rate risks and penalty risks.

Pros and Cons of Short-Term CDs

Pros and Cons of Long-Term CDs

Advantages of Short-Term CDs

Short-term CDs are a popular savings option and have several key benefits worth discussing.

Quicker Access to Funds

When you put your money into a short-term CD, you’ll be able to access it again penalty-free in less than one year (and usually in as little as a few months).

Reinvesting Options

Short-term CDs give you more options for reinvesting your money. For example, when interest rates are rising, short-term CDs allow you to quickly take advantage of those higher rates. You could also choose to reinvest your CD funds into a different type of asset, such as stocks.

Lower Risk of Penalty

CDs usually charge early withdrawal penalties if you take your money out before it reaches maturity. Because short-term CDs have shorter terms, you’re less likely to need your money early and end up paying a penalty. Additionally, short-term CDs often have lower penalties than long-term ones.

Flexibility

Short-term CDs provide ultimate flexibility for your savings goals. You can adjust your savings strategy more often and are able to access your money more often.

For example, suppose you’re considering buying a car but aren’t sure exactly when. You want to earn a bit of interest on your down payment savings, so you put the money into a CD. If you choose a short-term CD, you’re ready to buy a car on much shorter notice. And if your CD term ends and you decide you don’t want to buy a car after all, you could invest your down payment savings elsewhere.

Advantages of Long-Term CDs

Long-term CDs also have some benefits and are well-suited to specific situations.

Generally, Higher Interest Rates

Long-term CDs often pay higher interest rates, leading to greater potential earnings. The higher rate comes in exchange for agreeing to lock up your money for longer.

Of course, this isn’t always the case. For example, in the fourth quarter of 2024, when interest rates are expected to continue falling, banks are offering higher rates on short-term CDs.

Ideal for Stable, Long-Term Savings

If you’re saving for a long-term goal and want to keep your money safe, a long-term CD could be an excellent tool to help you. As we mentioned, long-term CDs often have higher rates than short-term ones. They also allow you to avoid the volatility of the stock market.

Protection Against Falling Interest Rates

Just as short-term CDs allow you to take advantage of rising interest rates, long-term CDs protect you from falling rates. When you open a CD, you lock in your rate for the entire CD term. So if you lock in a rate of 4.00% APY and interest rates fall by several percent, you’ll continue earning your higher rate. Contrast that with someone who had a short-term CD — when their CD reached maturity earlier, they’d have to reinvest at a lower rate.

Disadvantages of Short-Term CDs

Though short-term CDs have some definite benefits, there are also some risks to consider.

Typically Lower Interest Rates

As we mentioned, long-term CDs generally have higher interest rates, while short-term CDs have lower ones. As a result, you have lower earning potential on your savings. A key exception is when short-term CDs offer higher rates during a falling rate environment.

Frequent Renewal Needed

Short-term CDs simply require more maintenance than long-term ones. As your CDs expire, you’ll have to open new ones to keep earning interest. CDs often have automatic renewal, but that means you’re stuck at whatever interest rate your current bank is willing to pay you. It’s often more profitable to shop around for the bank that’s offering the best current rates. But that’s added time and effort on your part.

Lower Earnings Over Time

Short-term CDs have lower overall earnings, especially at times when interest rates favor long-term CDs. Additionally, your money has less time to earn interest and compound in a short-term CD, meaning you’ll reach the end of your term with lower earnings than you would on a long-term CD.

Disadvantages of Long-Term CDs

Long-term CDs also have some disadvantages that make them a poor choice for some situations.

Early Withdrawal Penalties

The longer your CD term, the more likely it is you’ll have to access your money earlier and pay early withdrawal penalties. Additionally, long-term CDs tend to charge higher penalties. For example, a bank may charge one month’s interest as a penalty on a short-term CD but several month’s interest on a long-term one.

Locked In for Longer Periods

Long-term CDs offer less liquidity than short-term CDs. You agree to lock up your money for longer periods, meaning it’s more difficult to access for other purposes. For this reason, long-term CDs aren’t a suitable place to keep your emergency fund, even if it pays a higher interest rate.

You May Miss Out on Higher Returns

Long-term CDs have the benefit of guaranteed returns, but that guarantee could also be a downside. For example, if interest rates rise on CDs, you can’t easily reinvest your money to take advantage of those higher rates. You may be stuck earning a lower rate for years.

Factors to Consider When Choosing

When choosing the best CD term, there are a few factors you can consider.

Interest Rate Environment

The current interest rate environment is one of the most important factors that can help you decide the right course of action. If you know interest rates are going to increase soon (especially if they’re going to increase significantly), then a short-term CD may be a better option. Sure, you accept a lower interest rate upfront. But you know you’ll be able to reinvest your money at a higher rate soon.

On the other hand, long-term CDs may be a better option if rates are falling, but only if you know you won’t need to access the money. While short-term CDs may be offering higher rates at that time, those rates are temporary, and long-term CDs offer more interest rate protection over a period of years, not just months.

Personal Financial Goals and Timeline

Before depositing your money into a CD, consider your plans for the money and when you expect to need it. If you’re saving money for a vacation that’s coming up in six months, you know a short-term CD is the right choice. But if you’re buying a house in three years and want a place to save your down payment, you can feel comfortable opening a long-term CD.

Overall, it’s probably better to choose a term that’s shorter than necessary to avoid paying early withdrawal penalties than to choose too long of a term and pay the price.

Need for Liquidity

Consider your liquidity needs for the money you’re saving. For example, something like an emergency fund should be highly liquid. You could end up needing that money at literally any moment. On the other hand, money you’re saving for a specific purpose in the future doesn’t need to be as liquid. You know you won’t need to access it at a moment’s notice.

Risk Tolerance

Every savings and investment tool has some risk, even very low-risk tools like CDs. In the case of CDs, your risk is needing your money when it’s locked up and then having to pay early withdrawal fees to access it. Unfortunately, depending on your CD, your early withdrawal penalties could even eat into your principal if you haven’t earned enough interest to pay for it.

While you might feel comfortable taking on the risk of early withdrawal penalties in exchange for the interest rate and protection of a long-term CD, each person should evaluate their own risk tolerance to decide for themselves.

Which CD Is Right for You?

In most cases, it’s easy to figure out the best CD term for you based on your financial goals and situation. If you expect to need the money sooner or interest rates are on the rise, a short-term CD is probably the best option. On the other hand, if you’re storing long-term savings that you won’t need for years and rates are stable or falling, consider a long-term CD.

There’s also a middle ground, so you don’t necessarily have to choose between the two. A CD ladder is a popular strategy that involves depositing money into multiple different CDs with different terms. You have high liquidity since you frequently have new money coming available. You also diversify your interest rate benefits, enjoying the interest rate protection of long-term CDs while benefiting from interest rate fluctuations in your short-term CDs.

Choose the Best CD for You

Short-term CDs are those with terms of one year or less, while long-term CDs don’t mature for more than a year — often as many as three to five years. Both types of CDs have some key benefits and downsides to consider. The right CD term for you depends on your financial goals, liquidity needs, risk tolerance, and more.

When you’re shopping for a CD, it’s important to shop around to get the best rate. Online banks and credit unions often offer higher rates than large, national banks. It’s worth exploring rates with several different banks to find the highest APY. Finally, if you aren’t sure if a CD is right for your financial goals, consider speaking with a financial advisor to help you make the best decision.