Certificates of deposit might not seem like a good place to keep your money when interest rates are low, but they do offer security and stability. They’re covered by FDIC or NCUA insurance, and you can’t lose money unless you cash out before the CD matures and incur an early withdrawal penalty. Many CDs also pay better interest rates than many savings accounts, helping you to better keep up with inflation or even outpace it. If you’re looking for safety, here are six strategies that will help you earn as much interest as possible from CDs even when rates are at rock bottom.
To create a CD ladder, you purchase CDs that mature at regular intervals. The first might mature after one year, the second after two years, the third after three years, the fourth after four years and the fifth after five years. The benefit of staggering your CDs’ maturity dates is that if interest rates rise, you’ll be able to get a new CD at a higher interest rate without waiting too long for one of your CDs to mature or incurring early withdrawal penalties. As each CD in your ladder matures, you reinvest it in a new five-year CD (or whatever the longest term in your ladder is). For more on this topic, see How To Create A Laddered CD Portfolio.
By contrast, if you purchase only five-year CDs to get the highest available interest rate, and a year later rates go up, you’re either stuck earning a lower rate on all your money for the next four years or you’ll have to pay an early withdrawal penalty, which might negate the additional interest you’d earn from purchasing a new CD at a higher rate. With a ladder, while your longer-term CDs might end up paying below market rates, your money won’t be tied up in them too long because one will mature each year and give you the opportunity to reinvest at then-current, higher rates. Laddering in a low interest rate environment also means that your longer-term CDs can match or outpace inflation, and your shorter-term ones don’t tie up your principal for too long in case interest rates increase in the near term.
CD laddering also makes it easier to take advantage of short-term promotions for CDs with above-market rates since you’ll regularly have funds from a matured CD to reinvest. However, since promotional rates might only last for a week or two, your CD’s maturity date might not match up with one of these special offers. If it doesn’t, you can take the additional savings you’ve accumulated since you last purchased a CD and add another CD to your ladder at the promotional rate.
Here are some examples of the types of special promotions you might come across:
-In December 2013 and January 2014, Pentagon Federal Credit Union offered 3.04% APY on five-year CDs at a time when the next-highest rate available at any bank on five-year CDs was 2.16% APY.
-For one week in early May 2014, Hanscom Federal Credit Union offered 6.0% APY on a starter CD that lets customers deposit $5 to $500 per month for one year. The effective APY was about 3.3% since customers couldn’t invest all their principal up front, but that was still much higher than the best going rate of 1.25% APY on one-year CDs.
The biggest banks don’t pay anywhere near the best interest rates on CDs. Banks you might not have heard of, like General Electric Co.'s (GE) GE Capital, CIT Group Inc.'s (CIT) CIT Bank, Barclays (BCS), and VirtualBank, a subsidiary of Spain's Banco Sabadell, pay some of the highest rates, far outpacing national averages. These CDs are available online, so you can purchase them even if there isn’t a branch in your area. As of May 20, 2014, here’s how their rates compare:
Bank Minimum 1-Year CD APY 5-Year CD APY
Chase $1,000 0.02% 0.35%
Citibank $500 0.20% 0.50%
Bank of America $1,000 0.03% 0.15%
GE Capital Bank $500 1.10% 2.25%
CIT Bank $1,000 1.02% 2.25%
VirtualBank $10,000 1.07% 2.31%
Barclays $0 0.80% 2.25%
Rate-bump CDs, also called rising-rate CDs or bump-up CDs, let you request a higher interest rate once or twice during the CD’s term if market interest rates rise. Examples include the Achiever CD at CIT Bank and the Raise Your Rate CD at Ally Financial Inc.'s (ALLY) Ally Bank. You’ll have to keep an eye on interest rates, because the bank won’t automatically increase your rate; you must request the increase. There’s no guarantee that rates will increase, or that they’ll increase enough for you to notice the difference in the interest you earn, so make sure the CD’s starting rate is competitive.
CIT’s rate-increase CD requires an initial deposit of $25,000 and allows you to increase your rate once. You can choose a one-year CD paying 1.05% (CIT’s regular one-year CD pays 1.02% and has a $1,000 minimum) or a two-year CD paying 1.20% (CIT’s regular two-year CD pays 1.17% and also has a $1,000 minimum). In this case, you aren’t sacrificing a higher rate to get the rate-increase feature; not only do the rate-increase CDs’ rates slightly exceed CIT’s regular CD rates (albeit with a far higher minimum deposit requirement), they also compare favorably to the best CD rates in the market.
Ally offers a two-year CD that lets you raise your rate once, and a four-year CD that lets you raise your rate twice. Neither has a minimum deposit requirement. The two-year rate-bump CD pays 1.10% APY, while the four-year rate-bump CD pays 1.30% APY. For two- and four-year terms, Ally only offers rate-bump CDs, not regular CDs, but its two-year rate is competitive with the best CD rates out there.
Low Early Withdrawal Penalty CDs
An early withdrawal penalty is a fee banks impose when you withdraw your CD’s principal before the CD’s maturity date. The EWP might be six months’ interest on a 12-month CD, for example, so if you’ve had your CD open for fewer than six months, the penalty will partly come out of your principal, which is the only way you can lose principal when investing in CDs. But if you choose a CD with a lower EWP, you might be able to come out ahead by cashing out when interest rates increase and reinvesting in a better-paying CD.
EWPs vary significantly among banks, and the same bank does not offer the lowest penalties across the board on all CD terms. Also, as with rate-bump CDs, you want to make sure your EWP CD pays a competitive rate since you may not actually take your money out early. Some of the best CDs for achieving this goal as of May 2014 are as follows: AloStar Bank of Commerce has high rates and a mere 30-day penalty on one-year CDs, and a 90-day penalty on 18- and 24-month CDs. VirtualBank has some of the lowest early withdrawal penalties, and some of the highest interest rates, on three-, four- and five-year CDs, which have an EWP of just six months’ interest. Ally even offers a no early withdrawal penalty CD, but its rate is identical to Ally’s online savings account rate so there’s no advantage to choosing the CD.
In general, you’ll earn the best rates if you don’t keep all your CDs at the same bank. There is no one bank that offers the highest CD rates across the board for all CD terms, and the banks that pay the best rates can vary from week to week.
There is one case, however, where it can make sense to stay with the same bank, and that’s to earn a loyalty reward. When your CD term ends, banks usually automatically roll your principal and interest from the matured CD into a new CD of the same term at then-current market rates. Right after your CD matures, you’ll have a grace period of seven to 10 days to withdraw all your money without penalty. At this point, you should shop around for the institution that’s offering the best rate on the CD you want to buy.
A few banks try to prevent you from taking your money out by offering a loyalty reward in the form of a higher interest rate. For example, Pentagon Federal Credit Union offered such a reward last February, giving consumers who renewed their CDs rates 0.15% to 1.02% higher, depending on the CD’s term, than what it was paying to customers opening new CDs.
The Bottom Line
In a low interest rate environment, you need to make sure you’re not locking yourself into low CD rates long term, since rates might increase, and that the returns you’re earning beat or exceed inflation, since inflation erodes the value of your money over time. Achieving this dual goal is a difficult balancing act; longer-term CDs are most likely to pay enough to protect against inflation but they lack flexibility. Using a variety of strategies, including laddering, looking for promotional rates, purchasing online CDs, choosing rate-bump CDs and low early withdrawal penalty CDs and seeking out loyalty rewards can help you come out ahead and earn a real return that’s better than what a savings or money market account would pay while still keeping your money safe.