What Is a Variable-Rate CD?

Variable-Rate CDs Explained in Less Than 5 Minutes

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A variable-rate CD is a financial product that allows you to deposit money for a fixed amount of time with an interest rate that may fluctuate based on market conditions and other factors.

There are times when a variable-rate CD can be a prudent choice over a fixed-rate CD, especially if the current interest rates are low. Because the fine print on each CD is slightly different, it’s important to know what you’re looking for to determine if a variable-rate CD is the right place for your money. 

Definition and Example of a Variable-Rate CD

A variable-rate CD offers an initial interest rate for a set amount of time that may fluctuate based on market conditions or a pre-set schedule. CDs with variable interest rates may be tied to number of factors, from the Consumer Price Index (CPI), the prime rate, treasury bill yields, and the performance of various market indexes, such as the S&P 500.

Upon opening the CD, you should receive details about the factors that may contribute to the interest rate change, as well as when interest will accrue, restrictions, and what happens if you don’t choose to withdraw your money at the end of the CD term.

In contrast, a fixed-rate certificate of deposit has one interest rate for the duration of the term. This rate is determined based on a moment in time, or how much the bank is willing to pay regardless of any market changes over the term of the CD.

  • Alternate names: Multi-step CD, bonus rate CD, step-up CD

For example, you might be considering how to maximize your return on $10,000 in savings you hope to use in three years toward a mortgage down payment. You might evaluate 24-month CDs and realize you can lock in a fixed-rate 0.5% APR for the duration, or start with a 0.5% APR on a variable-rate CD with hopes that the market will yield a higher APR in the future. 

Depending on the market, part of the way into your CD, the rate might go up to 0.7%, resulting in a higher yield than wasn’t possible with the fixed-rate CD. On the other hand, if the market declines, you might end up with a 0.3% APR at some point, reducing your potential earnings compared with a fixed-rate CD. 

How a Variable-Rate CD Works

A variable-rate CD begins when you commit to placing a certain amount of money in the bank for a certain amount of time. In return, the bank offers you an initial interest rate with the condition that this rate will vary in response to indicators of how interest rates throughout the economy are changing. 

Each CD product, though FDIC-insured, will differ in details, from how much of a penalty you’ll incur if you make an early withdrawal to how the bank will respond when the CD term ends, (Some banks choose to automatically renew your CD unless you tell them otherwise.)

Automatically letting your CD roll over into a new CD may come with a disadvantage, such as a lower interest rate over the same length of time. When a notice arrives that your CD’s term is almost over, check current rates at a few banks or credit unions before allowing a rollover since you might find a better deal.

While fixed-rate CDs used to be the norm, many banks have created products that allow more flexibility and choice. Banks like Comerica Bank, for example, allow a one-time no-penalty withdrawal, as well as the opportunity to make additional deposits over time in your variable-rate CD. United Security Bank’s variable-rate CD products come with a base interest rate, and while the rate can go as high as the market allows, the rate will never fall below the floor rate of 0.25% over its two-year term.

Finally, some companies offer CDs where you can get a one-time or periodic boost to a higher interest rate without the potential for your interest rate to drop. These examples demonstrate the benefits of getting the whole story on a CD product before placing your money there for the long term. 

Alternatives to a Variable-Rate CD

The most common type of certificate of deposit tends to be the fixed-rate CD, which provides a hedge against future reductions in interest rates and allows you to lock in a rate during good times.

When rates are particularly low, variable-rate CDs become more appealing, but a common alternative is to consider a money market or high-yield savings account if they are earning similar rates in the current market. These accounts also have interest rates that are dependent on market forces to some extent, but unlike CDs, they usually don’t have steep early-withdrawal penalties. 

If you expect to need your money in the next few years, considering these accounts alongside a variable-rate CD can help you decide whether the difference between offered interest rates merits locking that money away for the full term of the CD. 

Key Takeaways

  • Variable-rate CDs offer an initial interest rate that may adjust as the market shifts based on market indexes like the S&P 500.
  • Variable-rate CDs are most desirable when fixed-rate CDs are offering very low rates, since locking in such a low rate with the latter eliminates the option for the market to improve and your rate to rise. 
  • The rise in popularity of high-yield savings accounts and money market accounts has an impact on the appeal of variable-rate CDs when the rates you can earn on all of these accounts are similar. 

Article Sources

  1. U.S. Securities and Exchange Commission. “Certificates of Deposit (CDs).”

  2. U.S. Securities and Exchange Commission. “Variable-Rate CDs.”

  3. Consumer Financial Protection Bureau. “What Is a Certificate of Deposit (CD) Rollover or Renewal?”

  4. Comerica. “Flexible Rate CD.” 

  5.  United Security Bank. “Variable-Rate CD.”