A step-up CD sounds like a good deal: a certificate of deposit where the interest rate rises automatically over time. But the numbers tell a different story.
The rates on these accounts are dramatically lower than what you can get from a traditional CD or a high-yield savings account right now. Step-up CDs typically start at around 0.05% APY and increase by up to 0.20% every seven to 10 months, maturing within 30 months. Composite rates on step-up CDs currently range from 0.10% to 0.35% APY. Today’s best traditional CD rates hover around 4% APY.
The conclusion is blunt: step-up CDs are generally not worth investing in. The rates are nowhere near competitive, even with the scheduled increases.
How step-up CDs work
Step-up CDs have predetermined rate increases that kick in at set intervals. You lock your money in for a fixed term, but unlike a traditional CD, the rate goes up over time rather than staying flat.
To compare a step-up CD against a traditional CD, look at the “composite APY” or “blended APY” on the step-up CD. That figure shows the average rate you will earn if you leave your money in the account until it matures.
The gap is stark. A $10,000 deposit in a 24-month step-up CD with a composite rate of 0.35% APY earns $70 in interest over the full term. The same $10,000 in a traditional 24-month CD at 4% APY earns $816.
That is more than eleven times the interest. The step-up CD’s scheduled increases do not close the gap, because the starting rate is so low and the increases are so small.
The callable catch
Some step-up CDs are callable. That means the bank can close the account before it matures and give you back your deposit and interest.
A callable CD is most likely to be closed if market rates fall below what you are earning on the account. The bank would rather pay you less than keep paying you the higher stepped-up rate.
This adds a layer of risk on top of the low returns. You could lose the benefit of the future increases if the bank closes the account when rates fall.
Step-up vs. bump-up CDs
Step-up CDs are not the only CD type with rising rates. Bump-up CDs also allow rate increases, but they work differently.
Step-up rates adjust multiple times automatically. Bump-up rates usually increase just once, and only if the issuing bank raises its available rates. If that happens, you have to request an adjustment from the issuer. As the investor, you need to try and time the market to ensure you get the biggest increase possible.
Both types of CDs are difficult to find, and both offer lower rates than traditional CDs. However, bump-up CD rates tend to be more competitive than step-up CD rates.
The timing problem with bump-up CDs is significant. You have to watch the market and decide when to ask for the adjustment. Get it wrong and you may miss the best rate entirely. Step-up CDs remove that guesswork, but they pay less for the convenience.
Where to find a step-up CD
Step-up CDs are not common. A few examples are available today:
- Citibank Step Up CD: This 30-month CD has a $500 minimum deposit, starts at a rate of 0.05% and adjusts up to a high of 0.15%.
- US Bank Step Up CD: Rates increase every seven months on this 28-month CD, and you will earn a composite rate of 0.35% APY.
- SouthPoint Financial Credit Union: Terms of 24 and 36 months are available with a $1,000 minimum opening deposit. Both terms earn 3.55% APY.
The SouthPoint option stands out because its rate is far higher than the other two. But it is the exception, not the rule.
Notice the difference between the Citibank and US Bank products. Citibank’s CD tops out at 0.15% APY. US Bank offers a composite rate of 0.35% APY, but that is still far below what you can earn elsewhere.
Better alternatives
You will not have any trouble beating the interest rate on a step-up CD. Several other fixed-rate investments and even some bank accounts pay higher returns.
Traditional CDs are the simplest substitute. For a short-term deposit account that pays a higher rate than a step-up CD, this is the obvious route. Current best rates sit around 4% APY.
Treasury bills are another low-risk option. With T-bills, the rate of return is guaranteed up-front, and you can choose terms ranging from four to 52 weeks. Rates are about 3.75% to 4.13%, depending on the term length.
High-yield savings accounts (HYSAs) offer variable rates, which means they can go up or down at any time. That said, many HYSAs are still delivering rates over 4% APY.
Money market accounts (MMAs) are another bank account that can outperform a step-up CD. Like HYSAs, the rates on MMAs can drop at any time, but the current national average (0.63%) is nearly twice as high as the composite rate on most step-up CDs. Many banks are still offering up to 4%.
The key difference between these alternatives and a step-up CD is flexibility. A traditional CD locks your rate in for the full term. An HYSA or MMA lets you move your money whenever you want. A step-up CD gives you neither a competitive rate nor easy access.
Why the numbers do not work
The math on step-up CDs fails on two levels. First, the composite APY is too low for most products. At 0.35% APY on the high end for most step-up CDs, your money barely grows. Second, the callable feature means the bank can pull the account when it stops being profitable for them.
Consider the $10,000 example again. In a step-up CD with a composite rate of 0.35% APY, you earn $70 over two years. In a traditional CD at 4% APY, you earn $816.
For most products, the step-up CD comes up short. The rate is lower, the term is locked, and the bank can close the account early.
The verdict on step-up CDs
Step-up CDs are not worth it for most savers. The composite APY is around 0.35% on the high end for most accounts, and your money can earn a lot more in a traditional CD, an HYSA, and even in some checking accounts.
The callable feature makes the deal worse. You take on the risk of early closure for a rate that is far below what other accounts offer.
If you want a guaranteed rate that rises over time, you are better off buying a traditional CD with a strong APY today. If you want flexibility, an HYSA or MMA gives you competitive rates without locking your money up.
Step-up CDs offer a solution to a problem that does not exist for most savers. The rates are too low to justify the trade-offs, and better options are widely available.
Source: finance.yahoo.com
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