Step up CD’s and its drawbacks

A Step up certificate of deposit is one of the flexi CDs. In this case, the interest rate on the certificate of deposit remains fixed for a year before they rise on the basis of a predetermined interest rate. This allows an investor to change the interest rate for a period of time. This allows greater accumulation of interests as in step up certificates of deposits the account’s interest rates moves up a certain predetermined amount over a specific period of time.

Difference between step up and normal CDs

Normal certificate of deposits are time deposit CDs. At the end of the predetermined time period of maturity, the investor withdraws the money and has the option to reinvest the money in other investment plans and programs. In Step up certificates of deposits the bank offers the investors chance to earn higher interest rates. In most cases the investors are informed by the bank that they are offering increased rates after a certain stipulated time on the normal funds deposited in a certificate of deposit. This opportunity allows the investor to increase the amount of invested money and earn greater interest rates. Therefore while normal certificates of deposits are time locked that is funds can neither be deposited nor withdrawn before the stipulated time, Step Up or Bumped Up certificates of deposit gives the investors to increase their deposit amount within the maturity period.

Drawbacks of step up CDs

1. Since in step up certificates of deposits, the bank offers to pay higher rate of interests after a stipulated time period therefore the initial rate of interest offered on the funds is very low as compared to traditional certificates of deposits. This makes earning on the funds in the initial days very nominal.
2. Even when the interest rates are increased after the stipulated time there will be no guaranteeing as such that at the end of the maturity date the earnings from this type of certificates of deposits will be more than the traditional ones.
3. The working of these step up certificate of deposits are also not same in all banks. Some banks do not offer a reasonable interest rise. There are others who allow increase in the rate of interest only once. The onus now lies on the investor to select the time when the rise in interest rates will be maximum ad he can benefit by stepping up his investment.

Finally the Step Up certificates of deposits does not always guarantee return. The increase in the interest rates depends solely on the rise in the interest rates of the market. If this does not happen then the investor’s certificate of deposit will see no rise in its interest rates. This will result in lower yield at the end of the term.