Understanding Bump-Up CDs and How They Work

A certificate of deposit (CD) is a type of investment product that pays you a relatively high interest rate as long as you commit to keeping your money in the CD for a set period of time, known as the term. Throughout the term, the CD grows, earns interest, and “matures.” At the final maturity date, you can withdraw your funds (including accrued interest) or roll it over into a new CD. If you take out your money before it matures, you’ll usually have to pay an early withdrawal penalty.

It seems simple enough, but there are also different types of CDs you need to know about before choosing to invest in one. For example, you could get a regular CD, a high-yield jumbo CD, or a bump-up CD (also called a step-up CD, jump-up CD, or trade-up CD). This last type is unique and more involved than the others. Let’s look at how a bump-up CD stands out by letting you respond to rising interest rates.

How Bump-Up CDs Work

Bump-up CDs are so named because you get to “bump up” your interest rate, usually one time during the term. You’re typically not limited on when you make that bump, but you’ll want to pull the trigger when you think interest rates are at the peak to take advantage of the higher interest rate.

Compared to a standard savings account, most CDs provide a higher yield. In fact, your CD’s annual percentage yield (APY), or the interest rate you earn, is typically among the highest available when you open it. The problem is that interest rates change, and most CDs require you to lock in your money for months or years. If the interest rate goes up during your term, you don’t get the higher rate.

But a bump-up CD solves that dilemma by allowing you to opt for a rate increase if the offered APY goes up. You just have to be strategic in your timing since you only get one chance — or sometimes two, on a longer term. Usually you select the bump-up option online through your CD account, but in some cases you might need to call the bank.

Bump-Up CD Example

Let’s say you get a 24-month bump-up CD with an option to increase your rate one time only. You start with an APY of 4%, but market interest rates rise, and six months later the CD rate is 4.5%. You can choose to do your bump-up then, and you’ll have the 4.5% rate for the rest of the term, which is 18 months. Even if interest rates drop again, you’re locked in at the higher rate.

But what if interest rates go up further? If you’ve already chosen the bump, you’ll stay at that rate and don’t have the opportunity to increase it again — but if you chose to wait, you can do your bump now and lock in the higher return. It’s like the internet meme that says, “You can only pick one. Choose wisely.” This is a bit of a guessing game, which requires studying the market and predicting future conditions to optimally pull it off. But if you don’t want to be stuck with one rate for several years, it might be the perfect choice.

Bump-Up CD Advantages

The obvious advantage to bump-up CDs is the ability to raise your rate during the term, but there are other benefits too.

• Rising interest rates: You can take advantage of increasing market rates, which you can’t do with a regular or jumbo fixed-rate CD.
• No falling rates: Your rate won’t drop like it could with a variable-rate CD, even if market interest rates go down.
• Federally insured: Like most CDs, bump-up CDs are usually FDIC insured for up to $250,000 per account holder, per bank.

Bump-Up CD Disadvantages

Even though you get to bump up your rate during the term, you’ll often start with a lower rate than fixed-rate high-yield CDs. There are a few other drawbacks as well.

• Only long-term: While other CD terms could be as short as a few months, bump-up CDs need time to take advantage of rising rates. So you’ll usually only find longer terms of at least 24 months.
• Difficult to time: Since you have to guess about the best time to lock in a new rate, you might accidentally bump too early … or too late.
• Low liquidity: As with most CDs, you have to commit your money for a set term. That means you have no liquidity, or ability to spend it, without paying an early withdrawal penalty — which is usually a few months’ worth of interest.

Alternatives to a Bump-Up CD

CDs and similar savings products come in several varieties, each with their own pros and cons.

• Regular CD: Regular (or traditional) CDs require a lower minimum deposit than jumbo CDs, and that includes many bump-up CDs. But smaller amounts usually also come with a lower APY.
• High-yield CD: High-yield CDs give you a higher rate than bump-up CDs to begin with. However, you’re locked into that APY for the entire term.
• Variable-rate CD: While many CDs are fixed-rate investments, variable-rate (or flex) CDs fluctuate with market conditions. Unlike bump-up CDs, rates can go up or down, and you don’t get to control when that happens.
• No-penalty CD: Most CDs charge an early withdrawal penalty if you take out your money before it matures, but no-penalty (or liquid) CDs don’t. They usually also have shorter terms, but a lower APY and limits or conditions on when and how much you can withdraw.
• High-yield savings account: High-yield savings accounts offer similar rates to CDs. But unlike a CD — even a no-penalty CD — you can usually withdraw, spend or move as much of your money as you want, any time you like.

Bottom Line

Bump-up CDs offer advantages over other types of CDs, but there are disadvantages as well. If you’d like to explore whether it’s right for you, take a look at Credit One Bank’s Bump-Up Jumbo CD.