Here’s What Happens When You Keep Your Emergency Fund in a CD

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A CD is generally not the best place for an emergency fund. Read on to see why, and learn where you should keep it. 

CD rates are looking pretty attractive these days on the heels of a series of interest rate hikes from the Federal Reserve. Some CDs are paying 5% interest or more for terms as short as six months.

You may be tempted to open a CD so you’re able to not only snag a higher interest rate on your money than what you’d get in a savings account, but also, keep that rate locked in for a period of time. But if you decide to house your emergency fund in a CD, you could end up making a big mistake.

Why CDs are the wrong place for an emergency fund

When you open a CD, you commit to keeping your money there for a certain period of time. It could be six months, 12 months, two years, or longer.

The upside of opening a CD is that you might get a higher rate on your cash than what a savings account will give you. And also, you’re guaranteed that rate until your CD matures.

By contrast, you could start out getting 4% interest in your savings account, and if rates fall a few months down the line, your rate could drop to 3% — and then continue dropping. If you sign a 12-month CD at 5%, that 5% is locked in.

But in exchange for that guarantee, you give yourself less flexibility with your money. That’s because you can’t take a withdrawal from a CD — that option generally doesn’t exist. Rather, if you need to access money in a pinch and your CD is your only source of cash, you’ll generally have to cash out your CD in its entirety. And that could cost you.

It’s common for banks to impose a penalty when you cash out a CD before it comes due. Now, those penalties will vary by bank. At Capital One, for example, cashing out a CD before it comes due will cost you three months of interest for a CD with a term of 12 months or less. For a CD term that’s longer than 12 months, the penalty is six months of interest.

But with a savings account, you can take a withdrawal at any time without penalty. And that makes a regular savings account a much better home for your emergency fund.

CDs are a great place for extra money

You may decide that your emergency fund should have enough money to cover six months of essential living expenses. But if you’ve reached that point and are able to save, say, another $1,000, then you may want to open a CD to snag more interest on it.

In fact, CDs are a great home for your extra cash. They’re just not the best place to keep emergency savings, namely because you might end up having to access that money to cope with an unplanned bill. So while the idea of accepting a lower interest rate on your cash and not being guaranteed that rate may not sit so well with you, think of this way — would you rather do that, or face a costly penalty for accessing money you need at a moment’s notice?

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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Maurie Backman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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