Although traditional certificates of deposit offer investors a fixed interest rate, CD rates across the banking industry fluctuate, meaning you can make more money on your deposit by opening a CD when rates are higher. CD accounts usually have better interest rates than regular savings accounts, in general — and like savings accounts, CDs are protected by federal deposit insurance up to $250,000 — so long as you leave your money in the time deposit account until it matures, you can avoid early withdrawal penalties and earn more interest.
Certain CD products allow you to take advantage of changing rates, whereas others lock you into a set rate for the duration of your deposit, even if rates have risen. As you think about when to buy CDs, consider the following reasons for rate changes to get the highest yield for your CD investment.
How and When CD Rates Change
Several factors — including supply and demand, inflation, the federal funds rate, and changes made by banks — cause CD interest rates to fluctuate. Rate changes occur over time, typically in conjunction with the changing economic climate.
Here are some common reasons for CD rates changes:
- Credit Supply and Demand: An increase in credit demand can cause rates to rise, whereas a decrease in demand causes rates to fall. Similarly, an increased supply of money will reduce rates, whereas a drop in supply will increase rates.
- Inflation: The higher the inflation rate, the more interest rates rise. Lenders offer higher rates to compensate for the falling purchasing power of the dollar.
- The Federal Reserve: The Federal Reserve Bank also affects interest rates. When the Fed purchases securities, banks receive more money they can use for lending, which lowers interest rates. On the other hand, when the Fed sells securities, interest rates rise. Historically, the Fed has raised rates as often as a few times a year to as little as once in nearly a decade.
- Bank Influences on CD Rates: Sometimes CD rates change because a bank or financial institution offers a time-limited promotional rate. In other cases, bank CD rate changes occur when a bank is bought out or acquired by another financial institution.
Interest Rate Rules for Different CD Types
Different types of CDs have varying structures and rules that affect CD rates. Some types of CDs, like bump-up CDs, let investors take advantage of changing rates, whereas traditional CDs lock investors into a set rate for the duration of the deposit. Choose the type of CD that best meets your investment goals and timeline.
When you put your money in a traditional CD, you agree to leave your money in the account for the agreed-upon time at a predetermined interest rate. If rates rise while your money is tied up in a CD, your money will continue to earn interest at the same rate you earned at the time of deposit. If you choose to withdraw your money from a time deposit early, you could face hefty penalties.
A variable-rate CD interest rate changes intermittently throughout the certificate’s term. Your CD rate might change depending on the rules set out by the issuer in the disclosure statement; choosing this type of certificate might result in higher or lower overall earnings for the certificate depending on market changes.
With a bump-up CD — also called a step-up CD or multi-step CD — rates increase, or sometimes decrease, at predetermined intervals to match market trends. Bump-up certificates, which are a type of rising-rate CD, might benefit owners when there’s an interest rate hike; however, some step-up CDs might cap rate increases. Investing in this type of product allows you to capitalize on an improving market without the need to reinvest your deposit.
Liquid CDs let you transfer money out of your account without incurring a penalty, though withdrawals may be restricted. Shorter-term liquid CDs — those with terms of two years or less — typically offer slightly lower interest rates, but give you more flexibility. This kind of certificate might suit investors who want access to funds prior to a CD’s maturity date, but also want a better return than the deposit rates on a checking account or other low-risk investment.
Callable CDs come with an embedded call option, which allows issuers to recall the certificate and pay the investor the principal and interest earned at any time during the term. If rates rise, issuers probably won’t call in the CD, but if rates go down, your CD might get called, leaving you with investable cash in a lower-rate environment.
Long-Term CDs vs. CD Laddering
When you open a traditional five-year, fixed-rate CD, you’re locked into that rate for the full five years, even if rates rise. Instead, consider using a CD laddering technique. Split your money into equal parts and invest in multiple CDs maturing at regular intervals. For example, invest a portion of your money in separate one-year, two-year, three-year, four-year and five-year CDs. If rates rise, you can reinvest your money at a higher rate after each CD term is up.
Using a CD ladder strategy enables you to secure better returns when the Fed is raising interest rates and minimizes the impact of low rates when rates are decreasing. If you choose a variable-rate CD, you should understand the how the rates will change, which could affect how much interest you earn.
Find Out: How CD Laddering Works
Knowing when CD rates will change is tough. Pay attention to the news, and if you hear of a Federal rate hike, keep an eye on CD rates. As you comparison shop for the best CD rates in your area, consider rising- and variable-rate CDs, which allow you to capitalize on an improving market. If you find a competitive rate you want to lock in, invest in a traditional certificate to help your savings grow more predictably.