What are the potential issues of step-up certificates of deposit?

A step – up CD is also referred as a bump – up CD, which is a common type of certificate of deposit, issued with a fixed rate of interest and the issuing authorities offer the customers additional options for increasing the rate during the deposit term. The issuing authorities allow the rate of CD to bump –up or increase the rate to the current prevailing higher market rate while maintain the same until maturity and withdrawal.

A step – up CD is a perfect type of certificate of deposit among various type of certificates of deposit as even when the deposit is made at a lower rate of interest, there will be an additional chance for enhancement of the rate of interest. These types of CDs are not offered by all banks and credit unions.

Example of a step – up certificate of deposit

A certificate of deposit is availed from a bank at the rate of 2% interest for a period of three years. The issuing bank increases the rate of certificate of deposit to 4.5% at the time of expiry of first year and the increased rate remains valid until the maturity period of the CD. The investor will earn the interest @ 2% rate for the first year and 4.5% for the remaining years. The increased rate of return is 2.5% which is issued for two years.

The major issue of a step – up CD is that if the issuing bank does not maintain rates in competition to other banks, the investors may never get a chance of bumping up the rates of interest, even when the same is done by other banks. Another issue that comes up is that the bump up option can be availed only once during the term of certificate of deposit. 

For instance, in the above example, if you opt for the bump up rate only at the end of second year, you will be paid at 2% rate for the first two years and 4.5% rate in the final year.

Again considering the above example, assume the rate is bumped up after 24 months for the second time at 6%. The investors who did not opt for the first bump up rates, will be paid the interest at 2% for first two years and paid at 6% in the final year. But if the investor opts for the first bump up rate any time before the second rate becomes active, the investor is not eligible to avail the second bump up rate.