by Saundra Latham @ The Simple Dollar wrote this article in January 2016 and recently updated on 07.19.16
The best CD rates largely depend on how long you’re willing to have your money tied up. As of January 2016, the average one-year CD interest rate is 0.27%, according to Bankrate.
But rates are volatile, get current rates with the tool below. It gave me a 1-year CD with a $2,000 minimum deposit with 1.2% APY – over 400% increase on the average mentioned earlier – from Synchrony Bank. I also found a 5-year CD with no minimum deposit and a 2.05% APY from Barclays.
Once you have a good frame of reference, you can decide if your local bank can compete with those rates, or if its best to go with the offers here. In my experience, most local banks can not touch rates found on the internet.
4 Tips for Finding the Best CD Rates
Now that you have a better understanding of today’s CD rate climate, the tips below can help you secure the very best CD interest rates if you’re willing to do the work.
Tip #1: Comparison shop
Obviously, your local banks and credit unions will offer a range of CDs. But before you embark on a tour of nearby lending institutions, consider using the Internet to land the best deal. As with savings accounts, online banks often offer the best CD rates because they don’t have as much overhead as traditional competitors. Online banks also typically make the web and mobile experience smoother for customers than brick-and-mortar banks.
Tip #2: Invest for a longer term — maybe
Traditionally, long-term CDs have higher interest rates. The obvious tradeoff is that you can’t get your hands on your money as fast. CD laddering, discussed below, can help you benefit from the best CD rates without locking away all of your money.
Tip #3: Look for special deals
Banks sometimes offer an attractive rate because of special circumstances. Maybe they need the cash, or maybe they’re trying to stand out in a crowded market. And it never hurts to ask in person whether your bank can do a little bit better on its rate.
Tip #4: Look beyond traditional CDs
Today’s interest rates are extremely low, and many experts say the tide is bound to turn by the end of the year. Liquid and bump-up CDs, described below, will let you take advantage of rising interest rates if you’re willing to accept a slightly lower initial rate. Of course, these CDs are inherently riskier, and if low risk is what drew you to CDs in the first place, they might not appeal to you.
Is a CD Right for You?
CDs are a stable, low-risk way to dip your toes into the world of investing. They’re easy to open and generally don’t require further decision-making once your money is secure. Traditional CDs guarantee you’ll get your investment back — plus interest earned with a predetermined interest rate — when your term is up.
If you can keep your hands off your money for the whole term, you’ll reap a higher interest rate than what’s offered by a typical savings account. CDs are worth a look for someone who is wary of higher-risk investments and can afford to sock money away for a longer period of time.
On the other hand, if you need easy access to your savings, a CD isn’t the best choice. For instance, you don’t want to put your emergency fund in a CD — that’s money you need to be able to withdraw immediately if the need arises. Also, the interest rate on a CD might not earn you much more than a savings account unless you set aside a lot of money for a long time. Finally, consider that interest rates can only go up from today’s rock-bottom levels, and you might not be pleased that your money is locked away at today’s low rates when they finally do rise.
If you’d rather have your funds in a spot that’s easier to tap, check out our guides on the Best Money Market Accounts and Best Savings Accounts. Both options will help you retain the liquidity you want at competitive rates.
Why are CD interest rates so low?
As I mentioned above, today’s current CD rates are nothing to write home about. In 2006, one-year CDs had an average APY of about 3.6%. With the exception of a brief rally in 2008, they’ve been falling ever since.
Why? There are several factors at play. One is that banks are sitting on a lot of money. The subprime mortgage bust forced many banks to merge and consolidate their reserves, meaning they don’t necessarily need your cash.
Plus, in response to the subprime mortgage crisis, the Federal Reserve lowered its target interest rates to record-low levels in order to stimulate the economy. In turn, this gives banks little incentive to raise their own rates. Finally, demand for safe, low-risk places to stash money is high, meaning banks don’t need high CD interest rates to attract customers.
Although the Federal Reserve has raised rates in 2016, don’t expect a miracle skyrocket in bank CD rates this year. Rather, experts believe the Fed is likely to move slowly in the coming terms.
Explaining CDs and CD Rates
A CD is basically a savings deposit, usually for a fixed period, entitling the bearer to receive interest. You can get a CD at just about any bank where you would open a savings account. Banks offer CDs with fixed time periods, called terms, that may be as short as a month or as long as five years or more. In most cases, you’ll face a penalty fee if you take your money out of the CD before the term expires.
Main Types of CDs
CDs are a fairly simple product, but banks offer several variations that can benefit you if you do your homework. Here are the main types of CDs:
- Traditional: These CDs lock away your money for a certain amount of time. The longer the term, the better your interest rate, which is fixed. Withdraw money early, and you could face a steep penalty fee. These penalties vary from bank to bank, but a fee equal to six months’ interest is most common on a one- or two-year CD, according to Bankrate.
- Variable rate: The interest rates on these CDs can change periodically according to certain indexes. The setup varies from bank to bank. You’re still guaranteed your initial investment but are vulnerable to fluctuating interest rates. These can be a better bet when you’re reasonably sure that rates will go up.
- Bump-up: Say you put your money in a CD with a certain term and interest rate, but then the bank offers another CD with a similar term but a better interest rate. You can “bump up” your CD to the new interest rate. However, you can typically only do this once, and your original rate may be a bit lower than those offered on traditional CDs.
- Liquid, or “no penalty”: If you need to withdraw your money before your term is up, liquid CDs will let you do that without paying a penalty fee. But, you’ll pay for this convenience with a lower interest rate.
- Callable: You’ll get a higher interest rate, but the bank reserves the right to “call back” your money and nix your CD before your term is up. So, if your CD has a three-year term and the bank calls it back after two, you lose out on a year of interest.
- Zero-coupon: You can purchase these CDs for much less than face value. For instance, you can get a $50,000 CD for $30,000, but you won’t see any interest until the CD is mature. And you still have to pay taxes on that anticipated interest every year.
- Jumbo: True to its name, a jumbo CD is an option only if you have lots of cash on hand, typically $100,000 or more. Your jumbo investment will typically net you a higher interest rate.
- Brokered: A brokered CD is simply a CD purchased on your behalf by a financial adviser or broker who does the legwork of finding the best rate. Of course, you’ll probably pay a fee for this service.
CD Terminology Primer
Remember, interest is denoted as APY, which stands for “annual percentage yield.” Don’t confuse APY for APR, which means “annual percentage rate” relating to loans and credit cards.
If you put $500 in a one-year CD with a 1.10% APY, you would make $5.50 in interest after the year-long term. Note that interest is always denoted annually, which can be confusing if you’re considering a CD with a shorter term. Say you deposit $500 in a 6-month CD with a 1.10% APY. You aren’t going to see $5.50 in interest after the 6-month term. Instead, you’ll see $2.70 — half the interest you would have earned in a year.
Another thing you’ll probably see denoted: How often your CD compounds — that is, when the interest rate is applied to the balance of your investment. This may happen as little as every year or as often as daily (or even continuously). Fortunately, if you directly compare the APY from current bank CD rates, you don’t have to worry about how frequently the CD compounds. The APY will already take that into account no matter how frequently it occurs.
Strategies to Help You Maximize Your Return: CD Laddering, Barbells, and Bullets
If you’ve poked around the world of CDs a bit, you may have heard of “CD laddering.”While a regular CD ladder, sometimes called a straight CD ladder, is the most common strategy, there are others variations to consider.
Simply put, this is an investment strategy in which you divide your total investment into several equal chunks of cash. You invest each chunk in a CD with a different term so that the CDs mature at different times.
For example, if you have $10,000 to invest, you might invest $2,500 in one of each of the following: a 1-, 2-, 3-, 4- and 5-year CD. When your first CD matures in one year, you can access your cash, plus interest earned, without a penalty. Then you can reinvest it in a 5-year CD with a better interest rate. You can do the same thing when the 2-year CD matures, then the 3-year CD, and so on. Eventually, you’ll have a 5-year CD maturing every year. You’ll be enjoying the higher APY of a longer-term CD, but you’ll still be able to access some of your money every year.
A major benefit of this strategy over investing all your cash in one longer-term, higher-interest CD is that you can access a portion of your investment relatively soon, when the first CD matures. Then, you can reinvest the money into a longer-term CD at a better interest rate and continue doing the same thing each time one of your CDs matures. Essentially, you get the benefits of better interest rates with the assurance that you can access some of your money periodically.
The downsides to CD laddering mirror those of investing in CDs in general. Even though you’ll have more access to your money, you still won’t have the liquidity that a savings account would offer. And portions of your money may be locked in at a low APY even as rates rise. Fortunately, being able to reinvest periodically can help offset the latter risk.
Barbells are for investors who want to maximize their return in the short and long term, but are OK skipping returns in between.
Using this strategy, you divide your money into very short-term CDs, such as 3 or 6 months, and much longer-term CDs, such as 5 years. So perhaps I put $2,000 in a 6-month CD and $2,000 in a 5-year CD. I’m betting current CD interest rates will rise long term, but I still have access to some of my cash. When the 6-month CD matures, I can then hold onto the cash, reinvest in more short-term CDs, or consider slightly longer terms or ladders, depending on the interest rate climate.
If you have a defined savings goal — or you’re a savvy investor who is predicting a healthy rise in interest rates that will peak at a certain time — consider setting up a CD bullet. For this strategy, you can put your money in CDs with several different terms, but your goal is to have them mature at the same time.
For instance, if I knew I wanted to put some money away for a 10-year anniversary trip in 2020, I could put some of my money in a 5-year CD right now. In two more years, I might invest in a couple of 3-year CDs. In four years, I might invest in a few 1-year CDs. All of them will mature right as I start to plan my trip. I don’t lose access to all those funds until the last year. And if I’m an investor who’s timed things right, I’ll have reaped a nice reward because of rising bank CD rates.
Beginning Your Search for the Best CD Rates
Now you know what kind of CDs are out there, why interest rates are low, investment strategies, and how to score the best rate. If you’re clear on the pros and cons of CDs and think they’re a good place to stash your cash, it’s time to shop. Begin by comparing current CD rates using our online quote tool. Remember to double-check minimum deposit amounts and term lengths so that you know you how much cash you have to lock away and for how long.