CD accounts usually have higher interest rates than savings accounts. Although traditional certificates of deposit offer a fixed interest rate, CD rates vary depending on factors like the bank and the term length.
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 decide when to buy CDs, consider the following reasons for rate changes so you can get the highest yield for your CD investment.
How and When CD Account Rates Change
Several factors — including supply and demand, inflation, the federal funds rate, and changes made by banks — cause CD interest rates to fluctuate. How often CD rates change depends varies on all those factors. Generally, 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 them 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 Bank: 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.
- Bank influences: Sometimes CD rates change because a financial institution offers a limited-time 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, like IRS CD rates, lock investors into a set rate for the duration of the deposit.
Here are the different types of CDs you can invest in:
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, 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 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.
Liquid CDs let you transfer money out of your account without incurring a penalty, though withdrawals might 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. A liquid CD 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 investments.
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.
Up Next: How CD Laddering Works
Laurel Jacketti Funk contributed to the reporting for this article.