Bump-up CDs: Definition and how they work

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When interest rates rise, raising certificates of deposit can help savers take advantage of rising yields.

In an environment of rising interest rates, rate-hike CDs (sometimes called rate-hike CDs) offer savers the opportunity to increase the CD’s annual rate of return without changing the terms.

Typically, rate-hike CDs allow only one rate hike during their term, suggesting they may be better suited for investors who understand the current interest rate environment and understand that rates will rise or fall. Some markup CDs have terms that allow customers to increase the price more than once.

The Federal Reserve has hiked rates sharply this year after keeping rates near zero since March 2020, when the COVID-19 lockdowns began.

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How Bump-up CDs Work

A CD is a savings account with a fixed maturity date and a fixed interest rate. Typically, the interest rate remains the same throughout the life of the CD, but there are some options that allow the rate to change. Value-added CDs allow account holders to increase their returns as CDs continue to mature.

The lifespan of an upgrade CD varies, but most are two to three years. Most Bumpup CDs have slightly lower interest rates than traditional CDs because CDs give holders the ability to raise interest rates. The minimum amount required for a prepaid CD varies from financial institution to financial institution, although some financial institutions have minimums as low as $500.

Many boost CDs allow a one-time boost in rate, but some (especially longer duration ones) allow multiple boosts. There may be rules about how much the rate can be increased at one time. It’s best to check the CD’s terms and conditions with your financial institution.

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Also keep in mind that if you withdraw funds from a CD before the due date, you will face a penalty unless it is a non-penalty CD.

Enhanced CD Example

Say you want to set aside $10,000 for home improvement. You assume you don’t need the money for a few years, but want it to grow safely and benefit from a rate hike in the interim. A two-year top-up CD may be ideal if you don’t want to need funds before the term expires.

If it turns out that you need your money within two years, it’s important to understand how much the prepaid penalty will cost to determine if a top-up CD is right for you.

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Advantages of booting CDs

The biggest benefit of upgrading CDs is the ability to increase your rates over time. If interest rates rise over the term, you can take advantage and earn more interest faster. Other types of CDs lock you into your APY, require the term to expire to take advantage of a higher interest rate, or impose an upfront penalty on closing the CD before it expires. With a Bump-up CD, you can more easily take advantage of rising interest rates.

Disadvantages of Enhanced CDs

The appeal of an enhanced CD is its flexibility, but it also has some drawbacks. Bump-up CDs typically start with a lower APY compared to other types of CDs, allowing banks to hedge against future APY increases. Depending on market conditions, a standard CD may gain you more interest over the life of an upgrade CD.

There is also no guarantee that the price will increase over the lifetime of the CD. Or, if rates rise and continue to rise, you could switch prematurely and miss out on a bigger APY hike.

How to open an enhanced CD

Opening a temporary CD is similar to opening other types of bank accounts, although fewer banks offer such accounts. Be sure to research the details of the bank’s offer, including term, top-up frequency, initial APY, initial deposit and early withdrawal fees.

You may find better deals from online banks, but you can find some cheap deals from traditional financial institutions by looking around. Once you have found a bank and account that suits your needs, you will need to complete an application form and review your account history.

Alternatives to Upgrade CDs

There are several alternative boot CDs to consider, depending on what you want from your savings:

Traditional CD: A term account with a fixed term and interest rate.
Step-up CD: Similar to bump-up CD, but it automatically increases your APY at set intervals.
CD Laddering: A strategy to maximize cost savings by removing multiple CDs with different runtimes.

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