What Is a Bump-Up Certificate of Deposit?
A bump-up certificate of deposit (bump-up CD) is a savings certificate that entitles the bearer to take advantage of rising interest rates with a one-time option to “bump up” the interest rate paid. The bump-up CD yields a lower rate than that of a similar CD with no bump-up option.
Bump-up CDs are also called step-up CDs.
Understanding a Bump-Up CD
A CD is a time deposit issued by banks to investors who purchase the CDs to earn interest on their investment for a fixed period of time. The savings product pays interest until it matures, at which point the investor or depositor can access their funds. Although it is still possible to withdraw money from a CD prior to the maturity date, this action will often incur an early withdrawal penalty. Usually, the interest rate stays the same for the life of the CD, but there are some options that permit changes to the interest rate. An example of a CD that allows an interest rate change is the bump-up CD.
A bump-up CD typically permits a one-time increase in the interest rate affixed to the security. However, CDs with longer terms may have the option to change rates multiple times over the term life of the certificate. Financial institutions may also have a cap on how high the yield can be increased (or bumped up) at any one time. When purchasing a bump-up CD, investors should ensure that they find out how many times they are allowed to bump up the interest rate, as well as whether they have to extend the term of the CD with each bump-up.
The bump-up CD allows investors to take advantage of rising rates without having to worry about the potential downward adjustments of a variable rate. The purchaser of a bump-up CD expects interest rates to go up. If rates increase, the holder can elect to increase the interest rate to the current higher rate.
For example, assume a bank issues a CD with a five-year maturity date and a bump-up option. The current interest rate on the CD is 2%, and the prevailing yield in the market increases to 2.9% before the CD matures. Investors can exercise their bump-up options, increasing their yield to 2.9%. If interest rates don’t rise, there is the opportunity cost of having to keep the lower interest rate for the term of the CD. If rates decline after the bump-up option on the CD is exercised, the new higher rate on the CD cannot be changed. In effect, the investor is protected against losing any interest during the decline.
Starting rates on bump-up CDs are lower than the rates on comparable traditional CDs. Hence, investors of CDs with bump-up options are at a disadvantage if interest rates decrease or remain unchanged for the life of the time deposit given that they would not get as much yield as the higher-paying traditional CDs.
What is a step-up certificate of deposit (CD)?
A step-up certificate of deposit (CD), also known as a bump-up CD, offers investors a special option to increase their interest rate one time, as rates in the market rise. This is a great opportunity to build a higher rate of return than regular CD options.
Can I increase my interest rate on a CD more than once?
Regular CDs do not allow you to increase the interest rate. Bump-up CDs typically give one opportunity to increase your rate. Multiple rate raises are usually only permitted for bump-up CDs with longer term periods.
Is a bump-up CD worth it?
Bump-up CDs are worth it if the market’s interest rates increase during the term of your investment. If rates don’t increase, then a regular CD is a better option because they have higher starting interest rates than bump-up CDs. It all depends on the market and the investor’s attitude toward their investments.