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A certificate of deposit (CD) offers higher interest rates than you can earn from a bank's standard savings accounts, and they're making headlines as rates continue to climb. When you buy a CD, you lock in a fixed interest rate and agree to keep your money in the CD until it matures.
If you want to withdraw your money before the maturity date in order to purchase a new CD that offers higher interest rates, you'll generally have to pay an early withdrawal penalty. With bump-up and step-up CDs, however, you can take advantage of rising interest rates without paying a fee or opening a new CD.
What Is a Bump-Up CD?
A bump-up CD, sometimes called a trade-up CD, lets you increase your CD's interest rate in the middle of its term. Generally, you can only request a rate increase once during your CD's term, with your new term being the bank's current offering on an otherwise identical CD.
For example, if you put $5,000 into a two-year CD with a 3% interest rate and, a year later, the bank offers a two-year CD with a 4% interest rate, you can request a "bump" up to the 4% rate. The new interest rate would then apply to your CD's balance for the remainder of its term.
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Pros and Cons of Bump-Up CDs
Bump-up CDs can give you some reassurance that you won't miss out if interest rates continue to rise, but there are also drawbacks to consider.
Benefits of a Bump-Up CD
- You can increase your CD's interest rate. The bump-up feature allows you to request a higher interest rate that matches the bank's current offering.
- They're more widely available than step-up CDs. It may be easier to find and open a bump-up CD than a step-up CD, another option that has an adjustable rate.
- You can choose when to request the increase. It's up to you whether you want to increase your rate soon after opening your CD or wait because you think interest rates may climb higher.
Disadvantages of a Bump-Up CD
- The starting interest rate may be low. Bump-up CDs tend to have lower interest rates than a fixed-rate CD with the same term from the same bank. Interest rates may need to increase a lot for you to request a bump and come out ahead.
- The number of potential bumps may be limited. You might only be able to request one interest rate increase during your CD's term.
- You have to request an increase. Having to choose can also be a disadvantage because you'll have to monitor the bank's current CD offering to determine if requesting a bump makes sense.
What Is a Step-Up CD?
Sometimes, banks use the step-up name to describe what we're calling bump-up CDs. Or to describe variable-rate CDs that have interest rates that rise and fall based on a benchmark rate. However, a step-up CD can also refer to a CD that receives several interest rate increases based on a predetermined schedule and rates.
With these types of step-up CDs, you don't have to request the interest rate increases like you would with a bump-up CD. And because the interest rate increases are predetermined, banks can show you the blended or composite interest rate for step-up CDs, which is the yield you'll get if you don't make any early withdrawals.
Pros and Cons of Step-Up CDs
Step-ups may be beneficial if you think rates will decline in the future, but they might not offer a good interest rate to start.
Benefits of a Step-Up CD
- Predictable returns. You'll know your CD's term, interest rate and when the rates increase when you get the CD.
- Steady interest rate increases. The CD has a steady interest rate increase schedule, such as an increase every seven months, and the new rate applies to your entire balance.
- Can be helpful if rates are declining. A bump-up CD is only helpful if interest rates rise after you open a CD, but your step-up CD's interest rate goes up regardless of current CD rates.
Disadvantages of a Step-Up CD
- Very low starting rates. The starting interest rate may be so low that, even after several steps up, you won't earn a lot of interest.
- Low composite rates could make them less appealing. After comparing fixed-rate CDs with the composite rate on step-up CDs, it might make more sense to go with a fixed-rate CD instead.
- Step-up CDs are not widely available. Many banks and credit unions don't offer step-up CDs, or they use step-up to refer to what we're calling bump-up CDs.
How to Open a Bump-Up or Step-Up CD
Here are several steps you can take if you're interested in opening a bump-up or step-up CD.
- Compare rates and terms. Banks and credit unions may offer different interest rates on their CDs. You don't have to open a CD with your current bank or credit union—compare current offerings based on how much money you want to invest and your desired term. Also, review the fine print terms, such as the early withdrawal penalty, to determine which CD will be best.
- Review your eligibility. Make sure you'll qualify for the CD based on the minimum balance requirements. If a credit union is offering the CD, you also might need to meet the eligibility requirements and become a member before you can get the CD.
- Complete the application. Once you've narrowed in on the CD you want, you may be able to complete the application online—it will be similar to opening a bank account online. Whether you apply online or at a branch, you may need to share your personal and identifying information, such as your date of birth, address, Social Security number and a copy of a government-issued ID.
- Fund the CD. You'll need to choose how you want to send the bank or credit union the money for the CD. The easiest option may be with an online transfer or by bringing a check to a branch.
If you already have an account with a bank or credit union, you might be able to open and fund a CD much faster. And it could be easier to manage your money if it's all in one place. However, compare these advantages to the potential earnings you could get by opening a higher-rate CD elsewhere.
Alternatives to Bump-Up and Step-Up CDs
CDs offer a guaranteed return without much risk, which can make them appealing if you're looking to earn money on your short- and medium-term savings. And bump-up or step-up CDs might be good fits if you think interest rates might rise, but they won't necessarily give you the most flexibility or highest returns.
As you're comparing rates, terms and options, here are several alternatives to keep in mind.
- Fixed-rate CDs: A fixed-rate CD will often start with a higher rate than you could get with a bump-up or step-up CD. It might be a better option for a long-term CD if you don't think interest rates will rise, or if you're looking for a shorter-term CD and think you'll earn more by having the higher rate from the start.
- No-penalty CDs: No-penalty CDs may start with a yield that's higher than bump-up CDs but lower than fixed-rate CDs. As the name implies, you won't pay any penalties if you close your CD early. These might be better than bump-up CDs because, if rates increase, you can close your CD and open a new, higher-rate CD. You also won't be tied to your current financial institution, which means you can shop around to find high-yield CDs.
- A CD Ladder: A CD ladder involves opening several fixed-rate CDs with varying maturities—such as six months, one year, two years and three years—and reinvesting the funds into a new CD as each CD matures. The staggered approach can give you regular penalty-free access to your funds while also helping you take advantage of rising interest rates.
- High-yield savings or money market accounts: You may also be able to find a high-yield savings account or money market fund that offers a high interest rate on your savings. You don't need to lock up your money like you might with a CD, but the financial institution can also lower your account's rate at any time.
The Bottom Line
You can't predict where interest rates will be in the future, but you can review your finances and goals to determine which types of savings and investment accounts might be good fits. If you're using CDs as part of your plan, bump-up and step-up CDs are worth considering if you're worried about changing interest rates affecting your overall returns.