The Pros and Cons of Rising-Rate CDs


Rising-rate certificates of deposit are a growing force in bank marketing campaigns, if not yet in consumer popularity. Bank of America (Stock Quote: BAC), Ally Bank and First Midwest (Stock Quote: FMBI) all offer some form of rising-rate CDs.

Rising-rate, or step-up, CDs give bank deposit investors the right to opt out of a current (presumably lower) CD rate and into a higher rate CD as interest rates rise.

With many economists predicting that bank interest rates are headed north, a built-in insurance policy that allows you to ramp-up to a higher rate sounds pretty good to CD investors.

But is the deal as good as it sounds? In some ways it is, and in some ways it isn't. Here’s how rising-rate CDs work.

Let’s say you buy a two-year CD at a rate of 1.23% (that’s the current average rate on two-year CDs according to the BankingMyWay Weekly CD Rate Tracker).

If nine months from now, the interest rate on that CD drifts up to 2.23%, you can pull the lever on the “step-up” provision in your rising-rate CD by notifying your bank you want the elevated rate. Now, some banks handle the step-up differently. First Midwest’s rising-rate CD, for example, automatically triggers a rate hike every eight months. But Ally Bank takes a different approach — it only allows you one interest rate boost within the term of its two-year rising-rate CD product.

That just goes to show you, if you want to take full advantage of step-up CDs, you have to read the fine print on each bank’s deal, and choose the one that makes sense for you. If you’re easily distracted from banking chores, as many busy Americans are these days, then an automatic trigger like the one First Midwest offers could be for you.

But if you’re a hands-on bank investor, step-up CDs at banks like Bank of America and Ally that allow you to choose when you kick in your higher rate might be the better call.

Other issues to look out for when choosing rising-rate CDs:

Low initial rates. Bank of America's 18-month Opt-UP CD offers you the “option to increase your rate one time after six months, if interest rates rise during the term of the CD, with no fee or term extension. If rates rise, you can increase your rate between your opening rate and the then-current rate offered by Bank of America on a new Opt-Up CD.”

But hold the phone. The bank starts you out at a paltry 1.25% interest rate — that’s pretty low compared to most 12- to 24-month CD deals. Rising rates may seem like a good deal, but only if you start off with a decent rate in the first place. Ally Bank’s two-year CD starts you out at 1.99% — that’s a much better starting point for a step-up CD.

The “what if” factor. Nobody can really guarantee when rates will rise. So you might kick yourself if you jump in and take the first rate hike deal that comes down the pike. But what happens if rates keep rising — and you’re stuck in a rising rate CD with a "one rise only" feature? That’s when an automatic rate hike deal, like the one First Midwest offers, can work for you — and against you. Sure, you get the rate hike, but you’re shut out for the next eight months.

Rising-rate CDs are an interesting concept. But if you’re in doubt, the better bet is to climb further out on the CD ladder and guarantee yourself a higher rate of return. That will take the guessing game out of the equation — and keep you in a higher rate, just the same.

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