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Step-up CDs offer predictable rate increases and are commonly found in rising interest-rate environments. These CDs can seem particularly attractive because they offer steadily increasing yields.
Still, step-up CDs may not be right for every investor. Here’s what you need to know before tying up your money in a step-up CD for the long haul.
Key takeaways
- Step-up CDs work like traditional CDs, except the APY increases over time rather than remaining the same.
- Even though the APY increases, that doesn’t necessarily mean you’ll earn a higher yield overall.
- Compare a step-up CD’s blended yield to traditional CD rates to ensure you’re getting a decent return.
How do step-up CDs work?
For the most part, a step-up CD functions like a traditional CD. When you open an account, you agree to leave your money in the account for a specified period of time in exchange for earning interest.
However, there is one big difference between the two products: A traditional CD earns a fixed interest rate for the term you choose, while a step-up CD earns a rate that increases over time. The increases happen according to a set schedule you’ll receive before opening your account.
Step-up CD example
Take a look at the following example to get a better sense of what the annual percentage yield (APY) could look like on a step-up CD with a 28-month maturity term:
- Months 1-7: 0.05%
- Months 7-14: 0.25%
- Months: 14-21: 0.45%
- Months: 21-28: 0.65%
Step-up CDs vs. bump-up CDs: What’s the difference?
Step-up CDs should not be confused with bump-up CDs. The two names might sound similar, but each product is distinct. Here’s a look at the differences between the two:
| Step-Up CD | Bump-Up CD | |
| Investor involvement | None: Rate increases happen automatically | Some: The investor must request each rate increase |
| Rate increase timeline | Follows a predetermined schedule | Only available if the bank raises rates for its new CDs |
| Number of rate increases | Typically 3 to 4 per term | Typically 1 to 2 per term |
| Initial APY rates | Usually lower because rate increases are guaranteed | Usually higher because rate increases are not guaranteed |
Pros and cons of step-up CDs
Step-up CDs have a few key benefits and disadvantages you should be aware of before opening an account, including:
PROS
- Guaranteed return: Like traditional CDs, step-up CDs offer a guaranteed rate of return on your investment.
- Less investor involvement: Because the rate increases occur according to a set schedule, you won’t have to put in any legwork, making it a low-effort investment.
- FDIC insurance: Most financial institutions that offer step-up CDs are backed by the Federal Deposit Insurance Corp. (FDIC) or National Credit Union Administration (NCUA), meaning your investment is protected from bank or credit union failure.
CONS
- Lower starting rates: Because the rates on step-up CDs increase over time, the starting rates are typically much lower than traditional CD rates. Often, that results in reduced earnings at the beginning of the term.
- Strict early withdrawal penalties: Similar to any other type of CD, step-up CDs impose early withdrawal penalties. You’ll face this penalty if you try to withdraw your money from the account before the term is up. The penalty is typically expressed as a certain number of days’ or months’ worth of interest.
- Callable CD risks : Step-up CDs are often callable, which means that the financial institution has the right to redeem them before the maturity date. This can happen if rates drop dramatically, and they are now able to offer new CDs at lower rates.
- Limited availability of CDs: Not all banks or credit unions offer step-up CDs.
Are step-up CDs a good idea?
No one financial decision is right for everyone, but investors may want to do their research before diving headfirst into step-up CDs.
A step-up CD promises rising rates, but the overall yield can end up being less than what you might have earned with a regular CD, says Matt Schulz, chief consumer finance analyst for LendingTree.
“Step-up CDs generally aren’t a great investment compared with regular CDs or even high-yield savings accounts,” Schulz says.
But if you’re not concerned with the highest possible return but want predictability and rising returns, a step-up CD could be appealing, he adds.
Investing tip: Consider the composite APY
You’ll see many different APYs listed when looking into step-up CDs. However, the most important one is known as the “composite APY.”
Sometimes referred to as a “blended APY,” this metric shows what the yield would be if it stayed consistent throughout the CD’s term.
It can help you make an apples-to-apples comparison between the rates offered by a particular step-up CD and other CD options on the market.
Alternatives to a step-up CD
If you decide that a step-up CD is not the right fit for you, here are some alternatives:
- Use a CD laddering strategy: If you like the idea of investing in CDs but hesitate to commit because of potentially declining returns, think about using a CD laddering strategy instead. You’ll invest in multiple CDs with different maturity terms, allowing you to take advantage of a wide rate spread without worrying about locking your funds up for too long.
- Consider investing in Treasury bills: If you’re in the market for a safe investment, consider Treasury bills. T-bills, as they are often called, are short-term securities that are issued by the U.S. government with a guaranteed rate of return stated upfront.
- Open up a HYSA or money market account: If you’re hoping to be able to access your funds when needed, look into opening a high-yield savings account (HYSA) or money market account instead. These accounts offer higher-than-average interest rates while keeping your investments flexible. Money market accounts come with debit card and ATM access; HYSAs don’t, but they may also be subject to transaction limits.