Step-Up Certificate of Deposit (CD)

Certificates of deposit (CDs) can be a good way to earn interest on your savings. However, unlike a traditional CD with a fixed interest rate, a step-up CD comes with the ability to increase your interest rate during the CD term, meaning you could earn even more money when the CD reaches maturity

Key Takeaways

  • Though you are guaranteed a return, your money is tied up and inaccessible unless you pay an early-withdrawal penalty. 
  • The annual percentage yield (APY), or interest rate, might be lower than you think. 
  • Alternatives to step-up CDs could provide better returns. 

What Are Step-Up CDs?

Like a traditional CD, a step-up CD means setting aside a fixed amount of money for a specific period of time. During the term of the CD, the interest rate could rise, meaning you’ll earn more on your money. 

With many step-up CDs, the rate increases are noted on a schedule so you know when they will go up and what the new interest rate will be. 

One key drawback to step-up CDs is that you typically cannot withdraw any of this money without incurring an early-withdrawal penalty. Therefore, it’s important to have enough cash on hand so you won’t need to rely on a step-up CD in case of any emergency. 

How Do Step-Up CDs work? 

On the surface, it looks like the interest rate increases for the CD term will yield a good return on your investment. However, step-up CDs often have a blended rate, or APY, which is a combination of the previous rate on the CD and the new rate. 

For example, at U.S. Bank, you could get a step-up CD with a 28-month term that increases its interest rate every seven months. According to the rate schedule, the interest rate starts at 0.05% and increases to 0.65% by the last rate increase in the CD term. However, the blended APY for the CD term is actually 0.35%.

Check the Blended APY

The blended APY is the combined interest rate on a step-up CD. This is the rate of interest you will receive over the term of the CD.

Advantages and Disadvantages of a Step-Up CD

If you’re looking to diversify your portfolio and want a guaranteed return, a step-up CD might be the right fit. However, it’s important to remember that when your money is locked into a step-up CD, you cannot access it until the CD reaches maturity; otherwise, you will incur an early-withdrawal penalty. 

Also, interest rates on step-up CDs are not great. You might find better rates on traditional CDs. In this case, you may want to build a CD ladder by purchasing several traditional CDs with various term lengths. These could provide guaranteed returns along the way that you could reinvest in either more CDs or other financial tools.  

Step-Up CDs vs. Bump-Up CDs

Many confuse a step-up CD with a bump-up CD because they both involve an interest rate increase. However, they are not the same. With a step-up CD, interest rate increases usually occur according to a predetermined schedule for the term of the CD. Owners know how much the interest rate will go up and when. 

With a bump-up CD, the owner has the right to request an annual percentage yield increase once during the CD term. Because you have to request it yourself, it could be difficult to determine the right time to request it to maximize on higher rates.  

Step-Up CD Alternatives

Because interest rates are so low on step-up CDs, a good alternative could be a high-yield savings account or a high-yield money market account. For example, using the U.S Bank step-up CD previously mentioned, the return on a 28-month step-up CD with a 0.35% APY and a $5,000 principal is just $41. 

Many high-yield savings and money market accounts have rates of 0.50% APY or higher. A deposit of $5,000 with a 0.50% APY over 24 months is $50.13. Not only would you earn more in interest, but you also could tap into that money more easily than with a step-up CD. 

Can I Access My Money in a Step-Up CD?

The money in a step-up CD is tied up until the CD reaches maturity unless you are willing to pay an early-withdrawal penalty.

When Does the Rate Increase on My Step-Up CD?

That depends on the terms of the CD. Some may increase every few months, while others increase each year of the CD term.

Can I Convert My Step-Up CD to a Traditional CD?

Yes, when the step-up CD reaches maturity, you can reinvest the funds into a traditional CD.

Article Sources
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  1. U.S. Bank. "Step Up CD."