Understanding CD Rates and Their Impact on Your Investments

Certificates of deposit (CDs) are a popular low-risk investment option that allows you to earn interest on your savings. However, CD rates can fluctuate due to various economic conditions and the Federal Reserve’s financial goals. Understanding these changes can help you make informed decisions about your investments. In this blog, we will explore why banks change CD rates, how changing interest rates affect investments, and whether keeping your money in a CD is a good idea.

Why Do Banks Change CD Rates?

The Federal Reserve, the central bank of the United States, sets the federal funds rate, which financial institutions use to determine the rates they offer on various financial products, including mortgages, personal loans, auto loans, and credit card annual percentage rates (APRs). This rate also influences the annual percentage yields (APYs) attached to deposit accounts like CDs, money market accounts, and savings accounts. When the federal funds rate increases or decreases, CD yields typically move in the same direction.

It’s common for the Federal Reserve to raise its target rate if inflation is running high. This increases the cost of borrowing money, which can help rein in consumer spending, reduce demand, and bring prices down. Conversely, the federal funds rate is more likely to decrease during a recession to stimulate economic activity.

How Often Do CD Rates Change?

CD rates don’t change on a set schedule. Instead, they fluctuate based on the Federal Reserve’s goals. For example, the federal funds rate decreased twice during the pandemic and reached an all-time low, but it has increased 11 times since March 2022. As of January 2024, the Federal Reserve’s target range was 5.25% to 5.50%. Some CD rates are currently as high as 5.51%, but yields are expected to begin declining in 2024.

How Do Changing Interest Rates Affect Investments?

If you have money in a CD, savings account, or money market account, changing interest rates can impact your returns. For instance, if you put $10,000 into a five-year CD with a 1.5% yield, you’ll likely be tied to that low rate, earning a total return of $150. CDs typically have fixed rates, and you can expect an early withdrawal penalty if you dip into the account before the term ends. These factors can work against you if you have money in a CD and rates begin to increase.

However, if yields are expected to drop, putting money into a CD could help you lock in a good rate before things change. For example, investing $10,000 into a five-year CD with a 5.6% APY would translate to $560 in interest.

Should I Keep My Money in a CD?

Deciding whether to keep your money in a CD depends on your financial position, your goals for the money, and other factors. Here are some considerations:

When a CD Could Be a Good Place to Keep Your Money

• Low-risk investment: CDs offered by banks are insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000 per depositor, per insured bank for each account category. Credit unions provide comparable coverage, making it unlikely that you’d lose money with a CD.
• No immediate need for funds: Withdrawing funds before the term ends could result in hefty fees, but a CD can be a great place to park money you don’t plan on using in the near future.
• Alternative to a savings account: APYs on high-yield savings accounts and money market accounts typically lag behind CDs.

Signs a CD Might Not Be for You

• Looking for more competitive returns: The S&P 500 has produced average annual returns of around 10% for the past century. Investing in the stock market involves more risk, but it can be a strategic part of growing your wealth over the long term.
• Lack of emergency savings: If you lack an emergency fund, you may need to pull money from a CD if you run into a financial surprise, resulting in fees that deplete your returns.
• Other financial goals: You might have other goals that feel more important than investing in a CD, such as buying a house or starting a business. Let your personal financial situation be your guide.

Can I Get a Rate Increase During the CD’s Term?

CDs generally have fixed interest rates, but there are some workarounds to consider:

• Bump-up CDs: These CDs allow you to increase your rate if yields rise in the middle of the term. You can usually do this one time.
• Step-up CDs: With a step-up CD, your rate will increase on a predetermined schedule. Keep in mind that bump-up and step-up CDs often start out with lower yields than fixed-rate CDs with the same maturity period.
• CD laddering: This involves opening several CDs that mature at different times. CD laddering can provide ongoing liquidity. When each CD expires, you can either reinvest your money or spend it as you please.
• Money market account or high-yield savings account: These options can make sense if you want easy access to your money or the ability to make frequent deposits—and if interest rates rise, yields should go up. However, APYs usually aren’t as high as CDs.

The Bottom Line

CD rates are closely linked to the federal funds rate. If the Federal Reserve decides to change it, you can expect CD yields to move in the same direction. The same goes for rates on credit cards and loans. Your personal financial situation and goals will determine if a CD is the right investment for you.

At O1ne Mortgage, we understand the importance of making informed financial decisions. If you have any questions or need assistance with your mortgage needs, don’t hesitate to call us at 213-732-3074. Our team of experts is here to help you navigate the complexities of the financial world and find the best solutions for your unique situation.