Step-Up CDs: What They Are And How They Work

If you’re concerned about the risk of loss when investing your money, a certificate of deposit (CD) may be right for you. CDs offer a fixed interest rate and often offer insurance protection from the Federal Deposit Insurance Corporation (FDIC), for credit unions, or the National Credit Union Administration (NCUA). Both can help relieve anxiety.

When you invest in a traditional CD, you agree to lock in your savings for months or years at a time at the interest rate set when you open the account. But with a step-up CD, you get something even more appealing: a promise from the bank that your interest rate will increase.

Sure, the promise sounds great, but that doesn’t mean Step Up CD is the best choice. Read this article to learn how Step-Up CDs work, how their yield compares to other low-risk savings products, and whether they’re worth adding to your portfolio.

What is Step Up CD?

Like traditional CDs, step-up CDs are savings accounts that allow savers to lock in interest rates for a set period of time without worrying about fluctuations (similar to savings or money market accounts). However, before the Step-up CD matures, the interest rate associated with the account increases by a predetermined amount on the scheduled date.

For example, a Step-Up CD starts with an interest rate of 0.3% and increases by 0.1% Annual Percentage Yield (APY) every six months over two years. The rate over time is:

• first 6 months: 0.3% APY
• next 6 months: 0.4% APY
• next 6 months: 0.5% APY
• last 6 months: 0.6% APY

Early withdrawal penalties still apply to Step-up CDs. This means you will have to pay a price to withdraw funds from your account before maturity.

Step-up CDs are offered by fewer banks than traditional CDs.

How Step Up CD works

Step-up CDs are sometimes called bump-up CDs. But in reality, they are two different products.

A Bump Up CD gives account holders the option to increase their APY at least once before the end of the term, upon request. For example, as of this writing, Ally Bank offers two-year and four-year bump-up CDs, which allow you to request an increase if the bank’s interest rate increases. The 2-year bump-up CD includes one request, and the 4-year bump-up CD includes two requests. However, increasing interest rates is only possible if banks start offering better interest rates.

Step-up CDs, on the other hand, provide preset interest rate increases automatically at regular intervals, says Greg McBride, CFA, chief financial analyst at Bankrate. When using bump-up CDs, you may be concerned about timing the rate increase perfectly. In such cases, a step-up CD may be a better option.

Features of Step Up CD

Here are some Step Up CD features to help you decide if a Step Up CD is right for your deposit.

• Low initial interest rate: Step-up CDs typically start at a lower initial rate than the fixed rate of a comparable traditional CD. Check your blended interest rate to see how much you’ll make overall, taking into account rising interest rates.
• Predetermined increase rate: Prices for Step-up CDs are not fixed like Bump-up CDs. These are predetermined and the account holder is notified when and by how much interest rates will increase during the period.
• Minimum deposit amount: Step-up CDs tend to have higher minimum deposits to open than other types of accounts, such as savings accounts. Prices often range between $1,000 and $2,500. However, this is not always the case. For example, at TD Bank, the minimum deposit amount is just $250 (as of September 18, 2024).
• Duration options: Because Step-up CDs are specialized products, they may have fewer duration options than traditional CDs. In most cases, the available period is at least one year, giving you plenty of time before interest rates increase.
• Early withdrawal penalty: Like most CDs, step-up CDs typically come with penalties for early withdrawal of funds. Depending on the length of the CD term, you may have to waive a certain number of months of interest.

Pay attention to blend yield

When comparing Step Up CD prices, be sure to look out for mixed APYs. Blended APY is the effective rate you’re earning on your CD balance, taking into account rate increases, rather than simply the amount you earn each interval.

For example, US Bank offers a 28-month step-up CD. The interest rate associated with a CD increases every seven months.

• first 7 months: 0.05% APY
• next 7 months: 0.25% APY
• next 7 months: 0.45% APY
• last 7 months: 0.65% APY
• (APY as of September 17, 2024)

However, the blended annual yield, or effective interest rate for the four periods mentioned above, is 0.35% APY. Therefore, if you withdraw your funds before maturity without incurring a penalty, you will receive an APY of 0.35%.

Step-up CD benefits are often much more attractive than traditional CD equivalents.

Step Up CD Alternative

If you want a fixed rate of return that steadily increases over time, a step-up CD may seem like a good option. But it’s not the only option. When comparing places to keep your money, consider the following alternative accounts and strategies.

Build a CD ladder. If CDs are a good fit for your portfolio and you’re concerned about lower interest rates, consider building a CD ladder. Deposit funds into multiple CDs at the same time with different conditions. When your short-term CD expires, renew it or replace it with a new one. At the same time, you’ll have long-term CDs in the mix that may pay higher yields than short-term ones.

Look at the penalty-free CD. Penalty-free CDs don’t increase your interest rate, but you won’t be charged an early withdrawal penalty if you need the money sooner than expected or if you find a better option with a higher yield.

Open a high-yield savings or money market account. The best high-yield savings and money market accounts offer competitive rates of return and allow you to easily withdraw your money without penalty (although there may be limits on the number of transactions you can make). Interest rates on both types of accounts fluctuate. That means it can go up or down at any time, but you may find much higher earning potential with these online bank savings products than with a Step-Up CD.

conclusion

Step-up CDs are an attractive option for those who want to take advantage of interest rate increases over the CD term without having to actively monitor their investments. While interest rate hikes can be a perk, it’s also important to consider interest rate trends.

“Like umbrellas on a rainy day, bump-up and step-up CDs tend to emerge and have the most appeal in rising interest rate environments,” says Bankrate’s McBride.

While a guaranteed rate of return and a guarantee to increase that rate even higher may sound like great news, the blended yield on Step-Up CDs can be much lower than traditional CDs and other savings accounts. . Be sure to compare all options before finalizing your term.

— bank rate Rene Bennett Freelancer David McMillin contributed to updating this article.