What CD Should You Buy As Rates Go Up?

A certificate of deposit is a bank account that requires you to lock funds away for a fixed period of months or years in exchange for a fixed interest rate.

That rate often is higher than rates offered by other bank accounts. The trade-off is that you lose access to funds for periods of time.

But what if interest rates are rising?

That’s when you might consider buying a step-up certificate of deposit, also known as a step-up CD. These offer a variable interest deposit product in which the interest rate gradually increases throughout the term of the deposit.

As the certificate matures, you receive that increasing interest payment along with your initial deposit in return.

Below is just a hypothetical example of a step-up certificate of deposit on how rates would climb over time:

  • First six months: 1 percent APY
  • Next six months: 2 percent APY
  • Next six months: 3 percent APY
  • Final six months: 4 percent APY

Early withdrawal penalties still apply to step-up CDs, which means you’ll pay a price for pulling the money out of your account before it matures. In addition, step-up CDs are offered by fewer banks than traditional CDs.

Benefits and disadvantages

The key to a step-up CD is what’s called the “blended yield,” sometimes otherwise known as the “composite APY.” This is the average rate of annual interest you’ll receive over the lifetime of the product.

While a step-up CD might calculate its interest in six-month increments, your money is still locked up for the entire lifetime of the note.

Investors looking for short-term schedules should probably consider simply buying a standard CD with a six- or 12-month term instead since that will give them the flexibility that a step-up CD lacks.

Instead, consider a CD ladder

In a CD ladder, a lump sum of cash is spread across multiple certificates of deposit in order to benefit from a higher interest rate — usually in long-term CDs — while freeing up parts of that cash at short-term intervals.

For instance, you might invest $40,000 in a single 5-year CD. While you may earn a higher rate, you’re also giving up flexibility over your funds.

As an alternative, you can divide that amount into four rungs of a ladder of $10,000 each, which represent four different lengths of time (1-, 2-, 3- and 4-year certificates of deposit).

Each time you reach a rung on your CD ladder, you have the option of cashing out or renewing the CD for a later cash-out date.

A CD ladder allows you to access part of your investment each year while the remaining CDs are earning interest.