Bump-up CDs are increasing in popularity in the current economy. With the recession and the bank crisis causing financial difficulties in the economy, investors are trying to get the most out of their investments. Bump-up CDs help investors benefit from market increases so that they can earn more interest on their investments. Some may see bump-up CDs as just another stock market, but investors keep their interest no matter what happens to the interest rates. Bump-up CDs are not for everyone. Investors must evaluate their personal needs to determine if bump-up CDs are right for them.
How do Bump-Up Certificate of Deposit CDs Work?
Bump up CDs are CDs issued by financial institutions. These CDs are different from traditional CDs. Investors have the option to bump-up their CD rates when the market rates increase. Most banks only allow one bump up option for the duration of the CDs. For example, if the current interest rate on 5 year CDs is 3% and the market rate increases to 5% before the maturity date, investors can opt to bump-up their interest rate to 5% so that they can begin earning the higher interest.
Bump-up options can also help investors in the event rates decrease. In the event investors use their bump-up option to increase their interest rate and the market rate continues to decline during the terms, the investor is protected against losing any interest during the decline. For example, if investors bump-up the CD interest rate to 6% and the market rate decreases to 2%, investors are able to protect their interest from decreasing.
Advantages of Bump-Up Certificate of Deposit CDs
- Some banks offer more than one bump-up option. Most banks offer their customers a one-time bump up option. Some banks will allow up to two bump-ups over the terms of CDs that have 3-year terms or longer. Investors can double or triple their interest if the market value continues to increase over the terms of the CDs. Investors should discuss this option with their financial institution before committing to the terms of the CDs.
- The bump-up option does not increase the terms. The fact that the terms are not adjusted makes the bump-up option very enticing to investors. For example, if investors use their bump-up options during the third year on five year CDs, investors still have the same maturity date of their CDs.
- Investors benefit from the increase. Investors who invest in traditional CDs cannot benefit from the increase. The rate increase can mean a significant gain to investors. Investors benefit from the increase until the maturity date of their CDs.
Disadvantages of Bump-Up Certificate of Deposit CD
- Bump-up CDs have lower starting interest rates. Investors begin their investment at a lower rate of return than traditional CDS do. Bump-up CDs can be a great disadvantage if the interest rates decrease instead of increase. Investors benefit from keeping their original investment amount, by they do not gain as much interest as traditional CDs do because the CDs start at a lower interest rate.
- Bump-up CDs are a higher gamble than traditional CDs. Bump-up CDs are a gamble because investors have no ideas which direction the market rates will go. If investors use their bump up rate too early to benefit from a high increase, they may not benefit from a larger increase later on during the terms of their CDs, unless the bank offers more than one bump-up option. Investors can lose more money with bump-up CDs than they can with traditional CDs.
- Most banks only offer one bump-up option. It may be hard for new investors to decide when to use the bump up. Timing is everything with bump-up rates. Investors can gain or lose money when they use their one time bump-up option. Additionally, it may take several months to start receiving the benefits of the bump-up rates.
- Many financial institutions offer a fixed amount of time to use the bump-up option. The option may be lost forever if investors do not use the bump-up within a certain period. Financial institutions may set these dates according to historical market rates so that investors do not get the benefits of this option. If rates jump to a very high rate after the bump up option expires, investors do not get the chance to gain the additional interest.
Bump-up options can be beneficial and detrimental to investors. Starting CDs with lower interest rates is not a drawback if the interest rates increase over the terms of the CDs. Investors must evaluate their financial needs to decide if bump-up CDs are right for them.