Why Are Short-term CD Rates Higher Than Longer Term CDs?

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Certificates of deposit, or CDs for short, are often considered one of the safest investment options. That’s because they offer a fixed interest rate and are insured by the FDIC.

Read: How To Guard Your Wealth From a Potential Banking Crisis With Gold

But you may have noticed that there is something unusual going on with CD interest rates. Currently, most short-term CDs have higher interest rates than longer-term CDs — the opposite of how these interest rates are typically structured. Why is that?

In this article, we’ll explore the reasons behind this phenomenon and offer tips on choosing the right CD for your savings goals.

How Do CDs Work?

Both short-term and long-term CDs operate similarly. Like savings accounts, they’re deposit accounts that pay interest over time.

But unlike savings accounts, you can’t withdraw your funds from a CD until it has matured for a predetermined time frame. If you decide to withdraw your funds before that period ends, you’ll have to pay a penalty.

Typically, the longer you leave money in a CD, the more interest you can expect to gain. That’s because it acts as an incentive to keep your money with the bank for a longer period. For example, a five-year CD in June 2021 had a national cap rate of 1.70%, while a six-month CD was capped at 0.84%.

That’s why short-term CDs have traditionally been viewed as a more flexible option. Short-term CDs are offered in terms ranging from one, three, six and 12-month increments, suiting people with different savings goals and financial needs.

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However, that flexibility comes at a cost. If you want to earn more interest, you would have to commit your funds to the bank for a longer time frame and purchase a CD for a longer term.

Today, that rule is not necessarily true. For several reasons, many short-term CDs currently offer higher interest rates than long-term CDs.

Do Short-Term CDs Earn Higher Interest Than Long-Term CDs?

Today, short-term CDs are earning higher interest rates than long-term CDs because we’re currently seeing an “inverted yield curve,” meaning that long-term interest rates are lower than short-term rates.

This article will delve more into inverted yield curves more later, but first, here’s a comparison of some CDs based on their current interest rates.

TotalDirect Bank is currently offering CDs at the following rates:

  • 3-month CD: 5.16% APY
  • 6-month CD: 5.36% APY
  • 12-month CD: 5.33% APY
  • 36-month CD: 3.56% APY

Santa Clara County Federal Credit Union is currently offering CDs at the following rates:

  • 3-month CD: 5.12% APY
  • 6-month CD: 5.12% APY
  • 12-month CD: 4.59% APY
  • 36-month CD: 2.78% APY

As you can see, current long-term CD interest rates steadily drop as the term is extended.

Why Are 3-Month CD Rates So High?

Because the current trend is seeing an inverted yield rate that is pushing short-term CD rates up, understanding how this relates to inflation can have important implications for your investment strategy.

Financial analysts have observed that inverted yield rates often occur before recessions. Due to the Federal Reserve raising interest rates to fight inflation, there has been slowing economic growth. Between the slowing economic growth and the inverted yield curve, it appears that many financial institutions may expect a recession soon.

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Why Banks Can Offer Higher Rates for Short-Term CDs

Banks are factoring in the current high interest rates when offering short-term CDs while predicting that these rates will fall over time. In other words, a bank may be able to offer a high-interest-rate short-term CD and still make a profit due to the high federal funds rate. However, they don’t want to offer long-term CDs on these same terms because they may lose money if the federal funds rate drops in the future.

Since CD interest rates are guaranteed, it may make sense to capitalize on the atypical short-term CD rates in the face of a looming recession. At the moment, it’s easy to find rates above 5% in this category.

At the same time, there’s also a case for locking in a long-term CD at the higher-than-average rates currently on the market. If the Fed lowers rates over the next couple of years to stimulate economic growth, long-term CD rates will also drop, making your 3 to 4% APY on a five-year CD a smart investment in hindsight.

Final Take

When deciding between short-term and long-term CDs, evaluate your savings goals and timeline to determine which one is best for you. Take some time to shop around for the best rates because they may change frequently depending on market conditions and actions taken by the Federal Reserve.

While long-term CDs may have offered higher guaranteed payouts in the past, you could be missing out on higher gains over a shorter period offered by short-term CDs at present.

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Rates are subject to change; unless otherwise noted, rates are updated periodically. All other information on accounts is accurate as of June 16, 2023. 


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