Did You Know You Can Use CDs for Your Emergency Fund? Here’s How (Part 1)

Only one in five Americans has more emergency savings now than at the start of 2024, according to Bankrate’s most recent Emergency Savings Survey. If you’re one of those savers looking for ways to grow your emergency fund, help is on the way from an unlikely corner: Earning more interest by using certificates of deposits (CDs) and their early withdrawal penalties. 

Now, you’d be correct if you said that CDs aren’t traditionally considered compatible with emergency savings. The most significant deterrent to using a CD for an emergency fund is the withdrawal penalty, which is assessed when funds are withdrawn before the CD’s maturity. But you probably don’t know that withdrawal penalties can be used as an option built into CDs – not so different from those available for trading stocks. If you know how to use withdrawal penalties as options, you can possibly earn more interest on your savings. 

CDs have been out of style for so long that many people don’t know how a CD helps them grow their savings. Few people, for example, were interested in using CDs before 2022, and even fewer were incentivized to learn how to use one, because deposit interest rates were near zero percent for 15 years. You didn’t need a CD to lock in a rate of return on your savings if rates couldn’t go much lower. 

Today, however, the CD scene is quite different. Many people entered CDs during the past two years, boosting bank CD portfolios to record volumes, because rates were historically high. It now pays to utilize CDs to protect returns on your savings if rates continue to decline in the future, and it’s worthwhile to understand how to manage early withdrawal – and the associated penalty – to your benefit. 

Understanding deposit optionality

All deposit products provide at least two types of built-in optionality: an option when you open an account (or certificate) and options while using them. 

Banks’ deposit account menu – CDs, savings, and money market accounts – form a complete “option” set for you to consider when opening a deposit account. You’re choosing a position, just like an investor, within the future movements of interest rates. 

Generally, a callable CD fits an expectation that rates will rise or remain flat; if rates go down, the bank will likely “call” the CD and return your principal and interest. The same applies to money market accounts and savings accounts, though a bank will likely only lower the rate. Traditional CDs can be better for economic environments where rates likely will remain about the same or trend downward because you get to keep your high rate until the term of the CD. 

As I covered in “How to know what a ‘good’ interest rate is today,” most professional investors expect the Federal Reserve’s benchmark federal funds rate to range between 3.75 percent and 4.25 percent through December 2025. That means rates will likely decline or remain flat during the year, at least according to investors putting real money on the line as tracked by CME Group’s FedWatch. 

A traditional CD locked in at an annual percentage yield (APY) above 4 percent sounds good when the APY on a money market or a savings account could drop substantially if rate projections hold. But a CD has its own inconvenient caveat for emergency savings: It’s “locked in” for the length of its term, and charges a penalty if the funds need to be withdrawn early.  

If you want to grab those higher CD rates, consider “penalty” for early withdrawal as a misnomer. It is, in fact, an option with an associated cost. Treating it that way could allow you to harness higher CD rates on more of your emergency savings. It will also make you more aware that savings accounts have their own risks, even though they don’t have early withdrawal penalties. 

More savings earning higher interest

An emergency, or rainy-day fund is money typically set aside for unexpected expenses or to cover essential costs during a job loss. In the event of a job loss, many people aim for their rainy-day fund to cover three to six months’ worth of expenses such as mortgage payments or rent, electricity, food, internet and cell phone service. 

Added together, that’s not a small number. Assuming a 20 percent down payment, the typical mortgage payment, for example, is about $2,200 per month. Just for that mortgage payment, a rainy-day fund would need at least $6,600 to cover the mortgage for three months; six months would require $13,200 saved. To reach these balances, most people need something besides their hard-earned paycheck that’s adding to their emergency accounts. In that case, interest is very much your friend.  

Treating a CD penalty for early withdrawal as an option removes the stigma attached to a CD and allows you to shop a CD for its option.  

Most banks charge early withdrawal fees based on the APY the CD pays. You might see CDs with penalties of 90 or 180 days’ worth of interest. Translation: Some CDs have cheaper withdrawal options than others. Don’t think of CDs uniformly as locked-in deposits. Some are much less locked in and less costly to exit than others. 

Just like an investor in stocks, you should choose options that are most advantageous for you. Then, you can combine optionality in early withdrawal and compare it to savings account returns in beneficial ways. 

An example of leveraging your CD for your emergency fund

Let’s say you’ve saved enough money to cover up to six months’ worth of mortgage payments, or about $13,200.

If, for example, you lose your job, you may need some of that money to cover food and other expenses in the first month. But, after that, you may expect to cover all essential expenses with unemployment payments and side work. In that case, CD investments can be consistent with your emergency fund plan because you likely won’t need to spend all $13,200 at once. Let’s say you decide you can invest the $2,200 earmarked to pay the mortgage in months four, five, and six (a total of $6,600) in a 12-month CD because you’re unlikely to need it and that you keep the other $6,600 in savings. 

How does understanding early withdrawal “options” help you earn more interest based on this emergency plan? There’s a simple answer, but a more detailed explanation shows you how it’s beneficial to your emergency fund.  

The simple answer

You can generally find CDs that pay higher interest rates than savings accounts. For every $1,000 invested at a 1 percentage-point higher APY, your savings typically earn $10 more per year. If your plan holds and you never need to withdraw early from your CD, you make a 33 percent higher return in a CD versus a savings account. CDs outperform even more if interest rates decline. And, if you place funds in a CD with a 90-day penalty for more than five months, you don’t lose any of the money you put in if you withdraw early – you often earn a small return. 

A detailed explanation 

I got tired of reaching the end of the year only to see that interest added very little to my savings. So I asked: How could I invest my savings to produce higher returns without taking too much risk? I devised this approach to earn the same amount or more when interest rates may stay the same or decline. Here’s how I forecasted it using the $13,200 scenario (calculations are based on Bankrate’s Simple Savings Calculator and CD Calculator; all earnings reported are pre-tax): 

Comparing Scenarios: 

• For every $1,000 invested at a 1 percentage-point higher APY, I typically earn $10 more per year. It sounds small, but it can add up when your rate increases. 

  If I earn the national average APY of 0.57 percent on my savings accounts, for example, the $6,600 I have in a savings account gets just $37.62 for the year. Savings accounts found on Bankrate, though, would pay a rate of 3 percent APY or more and earn $198 annually. That would be five times more in earnings. 

• How do CDs factor in? Why not shop around for a better savings account and stop there? I look for CDs with an APY of at least 1 percentage point higher than savings accounts. The $6,600 in a CD would earn $264 at 4 percent APY for 12 months, a 33 percent higher return than $198 annually at 3 percent APY in a savings account.  

  That sounds like a compelling difference, but there’s even more value to me here: 

  My savings account will make $198, but only if rates don’t decline meaningfully. If your savings account rate becomes the current national average (0.57 percent) because the Fed lowers rates, you could earn as little as $37.62 for the year and miss out on $160.38. A CD takes those potential missed earnings off the table, and I would choose a CD that earns 1 percentage point more than in savings, creating a possible $424.38 difference in my earnings during a declining rate environment. 

• In accepting the potential cost of CDs’ withdrawal option, I hedge against lost interest, but I must also consider the cost of exercising my option to withdraw. 

  Fortunately, I only put $6,600 of my emergency fund into a CD. Supposing I spent the first $6,600 in my savings account and still needed emergency funds to pay the mortgage, my CD would only have six months left. If I withdraw in month six, I will still earn $67.10. If I withdraw in month seven, I will earn $89.55, assuming I selected a CD with a 90-day penalty. (I cover early withdrawal strategy more in Part 2 of this article.)

  The bottom line: If I don’t need to withdraw emergency funds during a job loss, I earn all savings and CD interest for a total of $462, a 16.7 percent increase over $396 if all $13,200 is in a savings account at 3 percent APY for the year. If rates were down during the year, I would reach that $462 because I prevented lost earnings of $160.38 on $6,600 using a CD. 

“Locking up your money” in a CD protects earnings if the Fed drops rates; without it, your potential lost earnings for $13,200 in a savings account for a year is $320.76 – if your savings account rate becomes the national average early that year. Now, maybe you’d rather stay liquid and risk that loss, but that’s the choice: Protect interest earnings using CDs because you accept the withdrawal option or risk lost earnings because you believe you need full access to the entire $13,200 in a savings account.  

Bottom line

You work hard to earn your income and to make the spending choices that allow you to create savings. Understanding the cost withdrawal options on CDs can allow you to use CDs, which may provide the highest interest rates compared with other deposit products, to grow your savings more.  

Are you curious about other ways to use CDs to your advantage? Do you already have a CD with a more significant early withdrawal penalty than 90 days of interest? We’ll cover your options in Part 2 of this article.