Bump-up CDs: How to maximize your savings in a rising rate environment

Many savers believe all certificates of deposit (CDs) lock them into fixed interest rates until maturity. While that's true for traditional CDs, bump-up CDs offer a unique opportunity to take advantage of rising rates while still enjoying the safety of a CD.

What is a bump-up CD?

A bump-up CD, also known as a "raise-your-rate CD," allows you to increase your annual percentage yield (APY) during the CD's term without changing other features like term length or minimum deposit. This flexibility is the main difference between bump-up and traditional CDs.

Ben McLaughlin, president and CMO of Raisin, explains: "If you invest in a 12-month CD at 4.50% APY but are in a potentially rising rate environment, you could get a bump-up CD that might pay a lower rate initially, but then you get the guarantee that if there is an increase, at least once, you can bump up to that higher rate."

How bump-up CDs work

Bump-up CDs provide an interest-rate flexible savings product during times of fluctuating rates. Like traditional CDs, bump-up CDs typically offer:

• Terms ranging from 6 months to 5 years
• Minimum deposits from $0 to $2,000 or more
• Early withdrawal penalties

The key difference is that you, the customer, can request a rate increase once or twice during the CD's term, depending on the specific product. Here’s a breakdown of how they work:

1. Initial investment: You open a bump-up CD with an initial interest rate, often lower than traditional CD rates.
2. Rate monitoring: Throughout the CD's term, you monitor the interest rates your bank offers.
3. Rate increase request: When you notice a higher rate offered on similar CDs, you can request your bank to "bump up" your rate to match it.
4. Rate adjustment: The bank increases your CD's rate to the new, higher rate, and your CD now earns interest at this rate for the remainder of its term.
5. Limitations: Most bump-up CDs only allow one or two rate increases during the term, so timing is key.
6. Maturity: At the end of the term, your CD matures with the earnings based on the initial rate and any increases you requested.

It’s important to note that the bank won’t automatically increase your rate — you have to actively request it. This allows you to potentially benefit from rising interest rates without having to close your CD, open a new one, and incur early withdrawal penalties.

Benefits of bump-up CDs

Here are some primary benefits of bump-up CDs:

• Potential for higher APY: They offer savers the ability to earn higher returns on their savings when interest rates rise, unlike traditional CDs, which have fixed APYs despite upward interest rate changes in the market.
• Flexibility: You have the option to increase your rate once or multiple times, depending on the agreement.
• FDIC insured: The Federal Deposit Insurance Corporation (FDIC) insures bump-up CDs up to a maximum of $250,000 per account.
• Predictable returns: Once you lock into a particular agreement, your returns will stay consistent for the contract term. Should you ask for a rate hike, you'll still earn the new high APY even if market rates eventually dip.
• Peace of mind: A bump-up CD is a great alternative that offers you peace of mind and certainty, knowing you can always take advantage of changing rates should the need arise.

Drawbacks to consider

Though bump-up CDs are an enticing savings product, consider the following drawbacks before investing in them.

• Lower initial interest rates: Bump-up CDs often start with lower APYs than traditional CDs. Depending on how long it takes you to switch to a higher APY, you may earn a lower return on your investment unless rates increase significantly to compensate for a period of lower returns.
• Limited number of rate increases: You're usually only allowed one or two upward adjustments for the entire term.
• Opportunity costs: If rates remain stable or decline, you might earn less than a traditional CD.
• Decision complexity: Predicting the best time to use your bump-up option can be challenging.

Bump-up CDs vs. other CD types

To help you make an informed decision, let's compare bump-up CDs with other types:

Who should consider a bump-up CD?

Bump-up CDs might be a good choice for you if:

• You're risk-averse but still want to hedge your bets against rising rates.
• You want to diversify your portfolio's fixed-income streams.
• You're saving to achieve a specific long-term goal. By matching your expenses to the locked-in returns of a bump-up CD, you can reduce the worries and anxiety associated with market volatility.

Ohan Kayikchyan, a certified financial planner, says, "Bump-up CDs are ideal for conservative investors who want a predictable return and aren't willing to take risks in the stock market. They're also for people who know they don't need the money for a certain period, like a year or two."

How to choose a bump-up CD

When shopping for a bump-up CD, consider these factors:

• Initial rate: Compare rates across different banks to ensure you get a competitive offer. Be willing to live with trade-offs as you may get a higher initial return on a bump-up Cd, but it will come with a higher minimum deposit or longer term.
• Term length: Choose a maturity date that aligns with your long-term goals.
• Minimum deposit: Make sure the required deposit fits your budget and savings capacity.
• Bump-up frequency: Some CDs allow one rate increase, while others permit multiple increases.
• Terms and conditions: Pay attention to the fine print, including rules for requesting a rate increase, time limits for exercising your bump-up option, and any fees associated with initiating a bump-up.

Strategies for maximizing your bump-up CD

1. Monitor interest rate trends: Stay informed about economic conditions that might signal rate increases. Some factors that might lead to rising rates include high inflation or falling unemployment rates.
2. Be patient: Don't rush to use your bump-up option at the first small rate increase.
3. Compare with current market rates: Before initiating your bump-up, check if the new rate is competitive with other CD offerings.
4. Consider CD laddering: To maximize flexibility and returns, you can use bump-up CDs as part of a CD ladder strategy.
5. Time your increase strategically: If you have multiple bump-up opportunities, consider using one early in the term for a significant rate increase and saving the other for later.
6. Set rate alerts: Many financial websites allow you to set alerts for when CD rates reach a certain threshold, helping you time your bump-up effectively.

Alternatives to consider

If a bump-up CD doesn’t seem like the right fit, here are some alternatives:

1. No-penalty CDs: McLaughlin suggests, "If a person is worried about rates, I recommend a no-penalty CD. With this product, you get the prevailing rate for that tenure. If interest rates change, you can sell that CD, recover your money without penalty, and reinvest in a different investment vehicle or asset."
2. High-yield savings accounts: These accounts offer competitive interest rates and are more accessible. They’re ideal for short-term savings goals and emergency funds.
3. Money market accounts: These combine higher interest rates than traditional savings accounts with check-writing privileges, making them ideal for emergency funds or money you might need access to.
4. Stock market investments: If you have a higher risk tolerance, investing in stocks or index funds can potentially yield higher returns over the long term.

The bottom line

Bump-up CDs offer a unique blend of security and flexibility for savers. They're worth considering if you're risk-averse but still want a shot at higher returns when rates rise. Just remember, timing is key — keep an eye on rates and use your bump-up option strategically.