What Is a Step-Up Certificate of Deposit (CD)?

What Is a Step-Up Certificate of Deposit (CD)?
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You have some money that you would like to invest and earn a good rate of interest but aren’t sure where to put it. Certificates of deposit would be a good choice because they’re FDIC-insured and pay fixed rates that offer a higher annual percentage yield than money market funds. But they lock up your money for several years, and you don’t want to miss the opportunity to earn more if interest rates go up. What to do? Invest now or wait?

One solution would be to look into step-up certificates of deposits. These CDs allow you to receive a higher interest return in case CD rates go up, but banks all have different rules. Which step-up CD would best fit your situation? Let’s look at the differences.

What Is a Step-Up CD?

Regular certificates of deposit pay a fixed return for the term of the CD. You know right from the beginning how much you are going to receive. The rate never changes.

A step-up CD, on the other hand, raises interest rates at specific intervals and amounts as set by the issuer. Longer-term step-up CDs generally have a higher number of rate increases.

These periodic rate increases let you enjoy the higher returns from rising interest rates. You don’t miss out as you would if you had invested in a fixed-rate CD.

How Often Do Rates Step Up?

The number of rate increases varies by the issuer. For example, U.S. Bank offers a 28-month step-up CD with rate increases every 7 months. At the other end of the scale, BankFlorida offers step-up CDs with maturities of three, four and five years, but you can only increase the interest rate once, at a time of your choice.

Other banks offer different variations of rising rates. Wells Fargo offers a two-year step-up CD with rate increases at seven, 13 and 19 months. Citibank has a 30-month step-up with rate increases every 10 months.

A variation on the step-up CD is the bump-up CD. While some banks, like U.S. Bank, Wells Fargo and Citibank, set the dates and amounts of rate increases when you first open the account, a bump-up CD lets the customer decide when to ask for an increase.

How Much Do Interest Rates Step Up?

The issuer sets the amounts of the step-up rate increases and the conditions when you first open the account. This is an example of the current rates for a 28-month U.S. Bank step-up CD with increases every seven months:

  • 0.05% for first 7 months
  • 0.25% for next 7 months
  • 0.45% for next 7 months
  • 0.65% for last 7 months

The current blended APY for these rates is 0.35%.

Other banks may not be as clear. Ally Bank, for example, lets you raise your rate once if you have a 2-year step-up CD or twice for a 4-year CD and their rate for a comparable regular CD goes up. In this case, there is no guarantee you will ever be able to receive a rate increase.

BankFlorida has a similar offer. They give you the opportunity for a one-time increase to the bank’s current yield for a CD of the same maturity. You can choose the time to request an increase, but you don't know when or if you will be able to increase your interest rate. It depends on market conditions.

What Are the Terms?

Maturities for step-up CDs range from two years up to five years. Ally Bank and Wells Fargo start with 2-year maturities, while TD Bank and BankFlorida offer one of the longest maturities at five years.

U.S. Bank and CitiBank have mid-range maturities at 28 months and 30 months, respectively.

What Is the Minimum Deposit?

Each bank has a different minimum required deposit. Ally Bank is the lowest with no minimum deposit. At the other extreme, BankFlorida has one of the highest minimum investments at $10,000.

Other banks are in between. You can open a step-up CD at TD Bank for $250, Citibank for $500 and U.S. Bank for $1,000.

What Are the Penalties for Early Withdrawals?

Here again, you have to read the fine print because each bank has different rules on penalties for early withdrawals.

For example, the early withdrawal penalty with an Ally Bank step-up CD will cost you 60 days' interest. TD Bank allows full and partial withdrawals without penalty if made during a 10-day grace period at the beginning of each anniversary of the opening date of the CD.

Citibank will allow you to withdraw the interest earned penalty-free at any time but will charge you 180 days' interest if you withdraw any of the original principal amount.

BankFlorida will let you make one withdrawal up to half of your initial deposit without penalty.

What Are the Pros and Cons of Step-up CDs?

While the opportunity to take advantage of rising interest rates may seem like a best-of-all-worlds solution to meet your financial goals, you have to look deeper to determine the best strategy for yourself and see if step-up CDs make economic sense.

In the first place, most step-up CDs usually have a starting rate that is lower than the rates for comparable maturity CDs. This means that you're starting from behind, and your overall annual yield-to-maturity, even with a step interest rate increases, may be less than if you had simply invested in a single fixed-rate CD for the same term.

A good yardstick is to compare the APY of a step-up CD versus a comparable traditional CD. You want to make sure the APY of your step-up CD will be high enough to match or exceed the rate on a regular fixed-rate CD. Otherwise, you would have no reason to take the risk.

The choice of which bank’s step-up CD to select can be confusing. As we have seen, banks have different requirements for minimum deposits, different rules for the frequency and amounts of step-up increases and different penalties for early withdrawals.

Only by analyzing your own situation and learning the rules of each bank’s step-up CDs can you make a rational decision on which one to choose. You may find that a money-market account or a savings account might be more suitable for your cash flow needs and risk profile.