What a Fed Rate Increase Means for Your CDs

Savers have endured historically low interest rates for the past several years, but Federal Reserve rate hikes can lead to higher annual percentage yields on certificates of deposit, or CDs. If you own a CD — often called a share certificate by credit unions — here’s a look at what rate hikes mean for your savings.

Look for higher rates

CDs are great tools for people who want to grow their savings over a set time period. The longer a CD’s term, the higher the rate; most financial institutions offer terms of up to five years. But during the last few years, even CDs with five-year terms have had average APYs well below 1%.

Fed rate hikes don’t cause rates to skyrocket overnight, but they can encourage financial institutions to gradually increase their APYs. Why? Banks want to remain competitive and attract potential customers. If a few of your bank’s competitors start increasing rates, yours will likely feel pressure to do the same.

But again, don’t expect massive improvements. After the rate hike in December 2015, many of the biggest banks reacted by raising loan rates, while leaving savings rates mostly unchanged — a tactic that boosts financial institutions’ margins.

If you do find an alternative with better rates, remember that you’ll pay an early withdrawal fee if you close a current CD before the end of its term, also known as its maturity date, to move it to another institution. The penalties you’ll incur might nullify any gains. You could, however, open a new CD at a financial institution with better rates.

» MORE: What is a CD?

Ask for your bump up if rates go up

Many financial institutions offer bump-up CDs, which let you request a rate increase if your bank’s rates go up. In most cases, you can exercise this option only once during the term of your certificate. These types of CDs typically have lower interest rates than fixed-rate certificates, and many carry steeper minimum deposit requirements.

Another option: Step-up certificates

If you want a savings product that functions much like a bump-up CD, but with more predictable rate increases, consider investing in a step-up CD. These have interest rates that automatically increase at specific intervals. With a 28-month step-up CD, for example, you might start with a low APY, but your rate will go up every seven months.

Again, initial interest rates on these products tend to be low, and some of these CDs and share certificates are callable. That means you might never see the rate boost because the issuer might redeem yours before it matures.

Next steps

CDs can be a great way to set aside money for the future. And although a rate hike might not lead to dramatic changes, it’s still a good idea to monitor your bank or credit union’s response to the news and compare it to that of other banks and credit unions near you. For help on that front, check out NerdWallet’s best CD rates tool.

Tony Armstrong is a staff writer at NerdWallet, a personal finance website. Email: tony@nerdwallet.com. Twitter: @tonystrongarm.

This article was updated June 9, 2016. It originally published December 16, 2015.