Why You Shouldn't Rush to Open a CD, Even Though Interest Rates Are Rising

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KEY POINTS

  • CD rates have been on the rise in the wake of the Federal Reserve's interest rate hikes.
  • While you may be tempted to open a CD, you may want to hold off for a couple of reasons.
  • Rates could still climb higher, and now may not be a good time to tie up your money.


There's a danger in tying up your cash.

The Federal Reserve is on a mission to slow the pace of inflation. To achieve that goal, it's been aggressively implementing interest rate hikes that are driving borrowing costs up. That's bad news for consumers, because now, it's more expensive to carry a credit card balance or sign an auto loan. The good news, though, is that a rise in interest rates is making savings accounts and CDs a more lucrative prospect.

Over the past few months, both savings accounts and CDs have been offering higher interest rates to customers. And since CDs commonly pay higher interest rates than savings accounts, you may be tempted to open one, even though it means locking your money away for a preset period of time.

But before you rush to do that, it pays to consider the downside. In fact, here are two reasons you shouldn't rush to open a CD right now.

1. There's still room for rates to climb

When you open a CD, you lock yourself into a specific interest rate for a predetermined period of time (whereas with a savings account, your rate can change from day to day or week to week). Because the Fed isn't done raising interest rates, it could be the case that CD rates are even higher in a month or so than they are today. And so if you sign up for, say, a two-year CD, you might actually end up losing out.

2. You may want easier access to your money

When you have money in a savings account, you can withdraw any amount of your balance as you see fit. With a CD, there's really no such thing as taking a withdrawal -- you generally either keep your CD in place or cash it out in full. But cashing out a CD before its term is up usually means being penalized to the tune of several months of interest.

Meanwhile, the Fed's interest rate hikes have the potential to spur a recession. As borrowing grows more expensive, consumer spending is likely to decline. If that happens to a moderate degree only, it could do the trick of slowing down inflation without too much negative backlash. But if consumer spending declines to a drastic degree, it could fuel a widespread economic downturn.

In light of that, now may not be the best time to lock up a chunk of your money. If the economy worsens over the next six months and you lose your job during the first half of 2023, you may need to tap your personal cash reserves to cover your living costs while you're out of work. But if some of your money is tied up in a one- or two-year CD, that could be a challenge (or, you could get stuck with a penalty).

Think carefully about opening a CD

There are plenty of benefits to saving money in a CD, but before you rush to pump money into one, think about what your cash reserves look like, and think about whether it pays to hold out for a better rate. And if you are going to open a CD, you may want to stick to as short a term as possible to minimize your risks in both regards.

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