How do Step-Up CDs Work?

Here's a way to get higher interest rates from CDs over time.

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Certificates of Deposit are common vehicles for people to achieve some income on cash savings with relatively little risk.

CDs allow a saver to set aside cash for a specific term (ranging from a few months to a few years) and lock in interest rates. In exchange for having money tied up during that time period, CDs generally have higher interest rates than standard passbook savings accounts.

Many savers, however, may be reluctant to lock up their money in CDs as interest rates have recently been on the rise.

Fortunately, there are ways to lock in the stability and safe returns of CDs while also taking advantage of rising rates.  Step-up CDs allow a person to hold money in a CD and take advantage of a higher rate if it comes along.

Not all banks offer step-up CDs, and they often come with restrictions. It’s also important to read the fine print on the interest rates you’ll receive. But they can be a helpful option for those looking to maximize the returns on their cash holdings.

Defining Step-Up CDs

Banks and credit unions don’t always use the same terminology, so for the purpose of this article, we’ll use “Step-Up CDs” to refer to a CD with an interest rate that rises automatically at specific points in time. Some banks or credit unions refer to these as “Step-Up Rate CDs.” A CD of this kind will raise rates according to a predetermined schedule, such as an additional tenth of a point every six months.

The idea behind step-up CDs is to allow people to keep their money in the safety of CDs while taking advantage of rising interest rates

Some banks and credit unions use the term “Bump-Up CDs” or “Jump-Up CDs,” but those may refer to CDs that allow you to get a rate increase only upon request. With these kinds of CDs, an account holder can request that the rate rise once before the end of the CD term.

Usually, this request can only be made once, which makes things challenging for the account holder, as they are left trying to predict the most advantageous time to request a rate bump.

KS State Bank is one small bank that offers a one-time “Jump Up” option if the rate on the CD goes up, but it is only available for select CD terms.

Be sure to understand all the details about the interest rate on any CD before opening.

The Pros and Cons of Step-Up CDs

Step-up CDs offer a safe investment and the automatic rise in interest rates will ensure that earnings on the CD will outpace the rate of inflation. It also saves you the effort of researching CDs to find better rates.

On the downside, the starting interest rate on step-up CDs is often lower than traditional CDs. In many instances, you may do better keeping CDs in shorter terms and simply finding new CDs with higher interest rates upon maturity. For example, U.S. Bank offers a 28-month step-up CD with a 0.1 percent interest rate to start, rising 0.2 percent every seven months (to a max of 0.7 percent) until maturity. But the bank also notes that the “blended yield” –the amount you’ll actually receive if you keep the CD through maturity—is 0.4 percent, which is far less than what many banks offer.

Alternatives to Step-Up CDs

If you want to place your money in CDs but are concerned about rising rates, placing money in shorter-term CDs may be more appropriate for you. Locking up your money for a few months as opposed to five years will give you the flexibility to open new CDs with higher rates once the short terms end. The downside to this is that short-term CDs usually have lower rates.

Another approach is to set up a “CD Ladder” in which money is placed in multiple CDs with a variety of rates and terms. This allows you to lock in some money in long-term CDs with higher rates while having the flexibility to move some money into new CDs as rates rise.  

Savers can also get safe returns and protect against inflation through certain kinds of bond products. U.S. Treasury Inflation-Protected Securities (TIPS) are bonds that rise in value along with the Consumer Price Index.

This creates a low-risk investment that is protected from losing value due to inflation.