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CDs have always been a straightforward invest-and-wait savings instrument. But more recently two other CD options have emerged to help customers keep up with rising interest rates -- step-up CDs and bump-up CDs.
With standard CDs, you put down money and collect interest at an agreed-upon rate for the term of the CD. But step-up CDs and bump-up CDs feature APYs that rise over time to keep up with changes in the market. Which one offers the best CD rates often comes down to timing. Here's a closer look at these newer CD choices and whether they are right for you.
A CD is a financial account for earning a bit of interest on money you're willing and able to put away long term. Although it lacks the flexibility and access of savings or checking accounts, it compensates for this by offering higher interest rates.
CDs are typically found at banks, although other types of financial service providers such as credit unions can also offer them. Some stock brokerages offer them too.
The length of time you keep money in a CD is up to you since they come in a range of terms. A typical CD family will have terms from one month to five years. Some banks feature longer CD terms for up to 10 years. For the most part, the longer the term, the higher the APY (effectively, your interest rate). APYs for standard CDs are set by the issuer and are fixed for the entirety of the term.
With a CD you're effectively committing to keeping your hands off your money until the CD reaches maturity. This is because there are usually very stiff penalties for early withdrawal, which at times can negate what you stand to make in interest from the money.
A standard CD account pays a fixed return over the term of the CD, no matter how long that term might be. That's fine if you want a predictable rate of return.
But what if you're in an environment of rising interest rates? Investing in a long-term CD means you'll be missing out on investment opportunities that capitalize on those climbing rates.
A step-up CD -- which can also go by other names such as "step rate" -- goes some distance to address this by lifting its APY at specific, pre-defined intervals.
The number of intervals and the level of the raise(s) are both set by the issuer. The longer the term, generally the higher number of intervals, although there are exceptions. As for the magnitude of the APY raises, these are usually predetermined like the headline APYs of standard CDs.
Here's an example of the fixed rates and intervals of a 28-month step-up CD offered recently by a regional US Bank:
|Term||Interest Rate||Blended Rate|
|1st 7-month period||0.05%||0.35%|
|2nd 7-month period||0.25%|
|3rd 7-month period||0.45%|
|Final 7-month period||0.65%|
One big caveat with the step-up CD is, because its APYs rise, it begins by paying interest below comparable standard CDs. You'll need to do some calculating ahead of time to avoid ending up with a lower total return than you would have earned with a traditional product.
As with the above example, sometimes you'll see a "blended" APY published near the step-up rate increases. As advertised, this is a combination of all the CD's various interest rates over its term.
You should make sure that the blended rate is comfortably above the APY of a standard CD from the same issuer with a similar term. It's also wise to compare it to other CDs offered by rival banks and other financial institutions.
A close relative of the step-up CD is the bump-up CD. The two have many things in common, most notably the potential for a rise in APYs over the CD term. The main difference is that the timing of the bump-up CD's intervals is not fixed by the issuer, rather they're chosen by the customer.
The bump-up APYs are set by the CD's issuer, and will typically be in line with prevailing interest rates of comparable CDs it offers. The number of intervals is also mandated by the issuer, but again, the exact timing is up to the customer.
This can be a tricky proposition. If you pull the trigger too early, you could lose out if general interest rates climb higher than your raise subsequent to making the move. Pull the trigger too late, and you risk jumping on a higher rate long after other financial products have benefited from the uptick.
As with the step-up CD, the bump-up CD typically starts at an interest rate well below that of a comparable standard CD.
The decision to opt for a step-up CD or bump-up CD should depend on two things you're convinced will happen during the term of the CD under consideration:
You're in this for the money, remember, so you want the highest return possible when you park money in a CD. If you're doubtful or uncertain about either of the reasons above, it's best to be safe and opt for a standard CD -- at least the returns will be predictable.
With bump-up CDs it helps to have an eye on macroeconomic developments. That will help to better predict when interest rate raises might be coming down the pipe. Bump-up CDs succeed best as investments when the intervals are chosen in some advance of benchmark interest rate upticks.
Here are some other questions we've answered:
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