What Is a Bump-Up Certificate of Deposit?

A bump-up certificate of deposit, commonly referred to as a bump-up CD, is a unique savings certificate that offers the holder the opportunity to benefit from increasing interest rates by allowing a one-time adjustment to the interest rate paid. Initially, a bump-up CD may start with a lower interest rate compared to a standard CD, but with some exploration, competitive starting rates can be found on bump-up CDs.

Understanding a Bump-Up CD

A Certificate of Deposit (CD) functions as a fixed-term savings product offered by financial institutions such as banks and credit unions. CD investors earn interest until the maturity date when they can access their funds. While traditional CDs maintain a constant interest rate throughout their term, bump-up CDs present the flexibility of adjusting the interest rate during their lifespan.

A bump-up CD typically enables a one-time increase in the interest rate, which remains fixed until maturity. However, some longer-term CDs may allow for multiple rate adjustments over the certificate’s duration.

Bump-up CDs are sometimes known by alternative names such as step-up CDs, raise-your-rate CDs, trade-up CDs, or jump-up CDs.

When considering a bump-up CD, investors should be clear on the number of times the interest rate can be raised and any associated restrictions, such as a maximum limit on the rate increase.

While the starting rates on bump-up CDs tend to be lower than those of traditional CDs, investors may find themselves at a disadvantage if interest rates do not rise or decrease compared to standard CD rates.

Advantages and Disadvantages of a Step-Up CD

Advantages

• Lets you take advantage of rising rates

• No chance of rate dropping

• Ideal when rates are rising but may soon even out

• Federally insured

Disadvantages

• Only available for longer terms

• One chance to raise rate means you must time the market right

• Lower starting rates than their traditional CD counterparts

• Liquidity and inflation risks

Advantages Explained

• Lets you take advantage of rising rates: The bump-up CD allows you to take advantage of rising rates. You buy a bump-up CD expecting interest rates to go up. If rates increase, you can bump up the interest rate to the current higher rate and earn more money.
• No chance of rate dropping: Unlike a variable rate CD, which also lets you take advantage of rising rates, your rate with a bump-up CD can’t go down, even if prevailing interest rates drop.
• Ideal when rates are rising but may soon even out: If rates are increasing rapidly for now but may soon slow, a CD holder holding a bump-up CD could catch a last higher-interest wave before rates flatten or decrease. This could help relieve any concerns about missing the boat altogether.
• Federally insured: In addition, as will almost all CDs, most bump-up CDs are insured by the FDIC for up to $250,000 in total per depositor, ensuring you will receive your principal back. Bump-up CDs offered by credit unions are insured for up to $250,000 by the National Credit Union Administration (NCUA).

Disadvantages Explained

• Only available for longer terms: If you only want to lock up your money for a year or less, you may not find a bump-up CD. Bump-up CDs tend to be longer-term, such as 24 months or more.
• One chance to raise rate means you must time the market right: Bump-up CDs also force you to “time the market” and guess the best time to lock in a new rate. Most require you to contact the bank and request a rate increase. If you don’t enjoy keeping a close eye on the rates or feel nervous about pulling the trigger at the right time, a step-up CD may not be as good an option as a no-penalty CD.
• Lower starting rates than other CDs: On average, the beginning interest rate of a step-up CD is lower than that of other CD types, including variable-rate CDs, no-penalty CDs, and traditional CDs.
• Liquidity and inflation risks: Like a traditional CD, a step-up CD will come with early withdrawal penalties, typically several months’ interest earnings. These penalties can eat into your returns. In addition, inflation can also decrease the value of your earnings.

Example of a Bump-Up CD

To illustrate, consider a scenario where a bank offers a 24-month CD with a bump-up option. Initially, the CD yields a 2% interest rate. If market rates rise to 2.9% in six months, the bump-up option can be exercised, adjusting the yield to 2.9% for the remaining 18 months.

Once the rate is raised, it remains fixed even if market rates fall, safeguarding against interest losses.

However, if rates rise further to 3.5% in subsequent months, the CD rate cannot be further increased. This situation may entail a missed opportunity to earn higher returns elsewhere.

What is a step-up certificate of deposit (CD)?

A step-up certificate of deposit (CD), also known as a bump-up CD, offers a one-time option to increase your interest rate in response to rising market rates, providing an opportunity to enhance your returns compared to conventional CD offerings.

Can I increase my interest rate on a CD more than once?

Standard CDs do not permit multiple interest rate increases. Typically, bump-up CDs only allow for one rate adjustment. Exceptions may exist for bump-up CDs with extended term periods exceeding four years.

Is a bump-up CD worth it?

Bump-up CDs become advantageous when market interest rates climb during the CD term. While an alternative strategy could involve opting for a no-penalty CD to start anew with higher rates, the convenience of a bump-up CD appeals to those seeking a hassle-free approach. Assessing the market condition vis-a-vis your investment outlook can guide your decision between a regular CD or a bump-up CD.

Bottom Line

For long-term savings goals, a bump-up CD can offer peace of mind by addressing concerns about potential interest rate increases. When confident in the market trends and comfortable with the expected returns, reaching out to your financial institution to request a rate increase on your bump-up CD is a prudent move.

It is crucial to thoroughly review the terms and conditions of your chosen bump-up CD, including the number of allowed rate adjustments and any penalties for early withdrawals. Seek out bump-up CDs with competitive initial rates for a more favorable investment experience.