Key insights:
- A step-up Certificate of Deposit (CD) is a type of savings account that offers periodic rate increases on funds that you deposit in an account for a set period of time
- Step-up CDs offer a low-risk way to earn interest on your savings, but lack the flexibility of traditional savings accounts
- Before opening a step-up CD, it's crucial to compare options and understand how it fits into your overall savings strategy and financial goals
When it comes to building your savings, Certificates of Deposit (CDs) offer a low-risk way to earn interest on your hard-earned money. These savings accounts can come in many forms, including step-up CDs. Simply put, a step-up CD is a type of CD that offers periodic interest rate increases. That means you’d end up with a higher interest rate than you started with, leading to more earned interest. However, it’s vital to understand how these accounts work before opening one.
Let’s explore step-up CDs, how they compare to other CDs and what to consider before opening one.
How does a step-up CD work?
A step-up CD is a type of CD that offers periodic interest rate increases during the term. The term is the time it takes for the CD to mature, which is when you may access your money, plus interest. For example, Citi step-up CDs have a 30-month term and offer interest rate increases every 10 months.
Step-up CD interest rates increase automatically and are not tied to market movements. Instead, the increases are predetermined when you open the account.
As with traditional CDs, the account holder typically can’t withdraw funds before the CD term ends without paying an early withdrawal penalty. The exact penalty varies by financial institution.
Pros and cons of step-up CDs
It’s important to consider the potential benefits and drawbacks of a step-up CD before opening an account.
Pros:
- Predictable, guaranteed interest rate increases
- Earns higher rates in the later part of the term
- May be beneficial if the federal funds rate dips
Cons:
- May start with a lower interest rate than a fixed rate CD
- Funds are typically locked in the account until maturity, otherwise an early withdrawal penalty may apply
- May offer lower yields compared to high-yield or longer-term CDs
How does a step-up CD compare to other CDs?
Step-up CDs are distinct from traditional CDs and bump-up CDs, despite some financial institutions using the terms step-up and bump-up interchangeably.
The key similarities between all types of CDs are:
- You typically must keep your money in the CD for the full term
- You typically will be charged a penalty if you withdraw funds early
It’s more important to understand the differences between these three types of CDs.
- Traditional CDs: Interest rates are typically fixed for the full term
- Step-up CDs: Interest rates increase by a predetermined amount over the course of the CD term
- Bump-up CDs: Interest rates may increase, but typically only once per term and you must request the increase
While step-up CDs have interest rate increases, these are not necessarily higher rates. Step-up CDs may have lower rates early in the term compared to traditional CDs. As a result, some step-up CDs may yield less interest overall than some fixed-rate CDs, depending on the interest-rate environment when you open the CD as well as the term you choose.
What to consider before opening a step-up CD
Step-up CDs can provide a reliable way to earn interest on your deposit, but there are a few things to consider before opening one.
- Note the composite annual percentage yield (APY): APY is the annual interest you earn. It’ important to compare a step-up CD’s overall earnings for a period so that you can compare the total amount to other CDs and better understand your options.
- Review the interest rate schedule: Make sure you know when the increases kick in. If federal interest rates are trending downward, locking in those rate increases may be advantageous. On the other hand, a step-up CD may make less sense if rates are on the rise and you could get better rates later.
- Compare account features: Features such as early withdrawal penalties and minimum deposit requirements can vary widely, so comparing these features can help narrow down your options to find a CD that aligns with your needs.
- Align with your overall savings strategy: It’s important to consider how a step-up CD fits into your broader savings strategy and financial goals. These accounts may offer predictable interest, but you have less flexibility to access your funds than you do with a savings account.
Whenever you’re considering a CD, it’s crucial that you’re comfortable depositing your funds for the term of your CD, and that you have access to other savings during that time. That way, you’ll be well-positioned to keep those funds in the CD for the full term, ensuring your money will earn the promised interest.
Disclosure: This article is for general educational purposes. It is not intended to provide financial advice. It also is not intended to completely describe any Citi product or service. You should refer to the terms and conditions financial institutions provide for various products.
