Should You Put Your Emergency Fund in a 3-Month CD?

As interest rates on the best CDs start to fall, many savers are scrambling to lock in high rates before it's late. For those who don't have much extra cash on hand, that might raise an intriguing question: Would it be worth depositing your emergency fund in a short-term CD? After all, wouldn't it be better to lock in a high rate than let your money sit in a savings account?

It's a good question, especially if we're considering a CD that will mature in three months. However, for most people, I don't think it's wise to put your emergency savings in a CD, no matter the term. Here's why.

Why a CD isn't the best place for your emergency savings

Simply put, CDs are too contractually rigid to hold your emergency fund. Unlike savings accounts, you can't withdraw your principal freely. And if you try to break your CD contract before your term ends, your CD provider will charge you an early withdrawal penalty.

And yes. You can lose money in a CD.

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The early withdrawal penalty on CDs depends on your contract, but it's usually equal to a certain months' worth of simple interest. For example, a 12-month CD might assess a penalty of 180 days of simple interest if you withdraw before maturity. So, if you deposited $10,000 in this 12-month CD with a 5.00% APY, you would have to pay roughly $250 to cash out early (assuming your bank compounds interest daily).

Most 3-month CDs have especially brutal early withdrawal penalties. Since the CD term is short, many banks charge a penalty that's equal to your entire term. This penalty would essentially wipe out any interest you hope to gain.

Let's assume you find an excellent offer on a 3-month CD. The APY is currently 5.25% -- one of the highest CD rates you've come across. However, the early withdrawal penalty for terms less than 91 days is 89 days of simple interest. That means, if you break your 3-month CD after just one month, the CD issuer could take money from your principal to cover the difference.

Yeah. Ouch.

That's the main reason I wouldn't open CDs with emergency fund money: The penalties could drain your emergency savings. You might have three to six months of emergency savings when you lock into your CD. But if you're forced to pay a penalty after only a few weeks, you could have significantly less.

What about a no-penalty CD?

No-penalty CDs don't charge a penalty for early withdrawals. Typically, the CD provider will have a short no-withdrawal period, usually seven to 30 days, after which you get penalty-free access to your money.

This could make no-penalty CDs more conducive to emergency savings. In fact, you can find several no-penalty CDs with APYs above 5.00%.

Keep in mind that the nature of an emergency fund is to give you quick cash when you need it most. This is the top reason high-yield savings accounts make good vehicles for emergency funds, as they let you withdraw money with more flexibility. All in all, your emergency fund is meant to be boring, but boring in a kind of seatbelt way -- you don't realize it's there until it saves your life.