Bump-Up Certificate Of Deposit (Bump-Up CD): What It Is, Pros and Cons

Bump-Up Certificate Of Deposit (Bump-Up CD): What It Is, Pros and Cons

Fixed interest rate is the fundamental feature of the certificate of deposits (CDs). A bump-up CD can increase the annual percentage yield (APY)  you earn before the certificate of deposit (CD) maturity. 

The saver or bump-up CD-holder utilizes it for the rate increase option once or more times, favorably, in an increasing interest rate environment.[1] 

Banks and credit unions use the federal fund rate as a guidance when increasing the rates. This could allow growing your savings more efficiently and effectively than a traditional CD. 

Bump-Up Certificate of Deposit (Bump-up CD)

Key Takeaways About Bump-up CD:

• A bump-up CD establishes an option to exercise one time the rate increase request before it reaches its maturity terms. 
• Bump-up CD is a specific savings account bearing variable rates of interest.
• Generally, bump-up CDs are available for longer terms.
• A bump-up CD investment can prove an advantageous opportunity if the interest rate increases during the CD terms.

What Is a Bump-Up CD?

A bump-up certificate of deposit (bump-up CD) is also known as a "raise your rate CD". It is a savings account with a specific date to maturity, bearing an engaging once-time option to bump up the interest rate during the CD maturity. 

Compared to a standard CD, a CD with the bump-up option, initially, may start with a lower rate. You can tackle it with the search for CDs offering competitive rates. 

A CD account without bump-up locks funds in an account bearing single fixed rates, whereas, a bump-up CD comes with the flexibility of rates increase- an increase in rates before maturity than the initial rates offered on CD. Rates are increased for the same CDs. 

It helps boost savings depending on the length of CD terms and the amount of money invested in a CD account.

How Do Bump-Up CDs Work?

With varying features, a bump-up CD account works in the same way as the other CDs. A bump-up CD comes up with a positive entitlement of interest rate increase, keeping the term period the same. 

There is no need for further deposit or term period increase to avail of this facility. Banks and credit unions are the CD issuer-financial institutions of the bump-up CD accounts. 

The legally eligible investors or savers can open a CD account with a minimum deposit amount varying among CD issuer financial institutions, some require as low as $500 for CD account opening. 

A CD account locks up amounts for a specific period, depriving of the right to access and withdraw the amounts invested in the account. You can withdraw funds before the maturity date with the subject of early withdrawal penalties.[2] unless it is a no-penalty certificate of deposit (no-penalty CD). 

Initial rates on the newly opened bump-up CD account are often lower than traditional CDs. While making a bump-up CD investment, you agreed upon a once-fixed rate payment until the CD matures. 

You need to shop for CDs or alternatives offering competitive rates. Many banks offer promotional higher rates for CD investment, so carefully, read the terms before selecting any CD investment. 

How to Open a Bump-Up CD Account?

The process of CD working starts with the opening of a CD account. To open a bump-up CD account, visit or apply online to one of the banks, credit unions, or brokerage firms that is near to approach. After fulfilling the application, finally place the funds into a bump-up CD account. 

Many options affect the choice of CD. The most important factor is the interest rate earned over a specific period until it reaches maturity. 

For a standard CD, offered interest rates remain the same over the maturity period. Rates also remain lower for shorter terms and a lower balance of the amount invested in a CD account. A bump-up CD account usually confers an option to increase the interest rate according to the rules and regulations agreed upon by the savers and the CD issuers, while opening this CD account.[3]. 

Bump-Up CD Example: Imagine the Following

Let's say a bank issues a bump-up CD with a 36-month maturity date and the current annual percentage yield (APY) is 3.5%. The issuing bank allows one bump-up option during the CD maturity period. 

To achieve the best returns on CD, you continuously check the market and find an update that after 12 months, the rate has increased up to 3.75%. 

This is the time to exercise the bump-up option and earn up to 3.75% for the remaining 24 months. Remember, banks will not increase APY up to 3.75% for bump-up CD automatically for the next remaining term period, there is a need to request the rate increase. 

If rates decrease from 3.75% after utilizing the bump-up option, there is protection, the rate will be the same, and nothing is lost against the rate decrease.  

After exercising the bump-up option, if the interest rate increases, during the next 24 months, from 3.75% (the new rate after 12 months) to 4%. You can't make a further request for the rate increase, as the bank entertains only one bump-up option offered. 

Some banks make exceptions to longer-period CDs by providing more than one bump-up option. Ally Bank bestows "the raise your rate CD" an opportunity to increase the rate once over a 2-year term CD and twice over a 4-year term CD.[4]

Opportunity cost is a value forgone in selecting one decision. It is the loss of the potential gain on the alternative decisions or actions forgone and selecting the other alternatives. The current rate is 4% and still earning 3.75% APY, there is an opportunity cost of 0.25% as potential gain lost. The fund could invest in stocks, bonds, and high-yield savings accounts or invest in other investing opportunities making more than 3.75% [5].

Advantages and Disadvantages of Bump-Up CDs

A bump-up CD offers multiple rates of interest that could be earned by keeping the amount balance the same. Here are the costs and benefits during the maturity period. 

    A) Advantages

    1) Taking Advantage of Rising Rates:

One of the biggest advantages of bomp-up CD investment is taking part in the upward movement of rates in the economy and earning extra returns in the form of rate increases by exercising the entitlement of the bump-up option.

    2) Federally Insured:

CDs are considered subject to guaranteed rate earning and safe investment. Almost all bump-up CDs are insured. Bump-up CDs issued by banks are insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000, per depositor, per ownership category.

Bump-up CDs offered by credit unions are federally insured by the National Credit Union Administration (NCUA) up to $250,000, per depositor.[6] [7].

    3) Gives Your Savings a Boost

The bump-up CD has the potential for higher returns. The flow of rate increase may slow soon and you can take advantage of a high-rate wave. It boosts your savings. Typical bump-up CDs start with slightly lower rates and potentially result in overall greater returns.

     4) Protection against Rate Decline

The Bump-up option over the maturity period provides protection against the current rate decline. You can adjust the rate by exercising the bump-up option. A potential decline in rates in the future couldn't decline the rates on pump-up CD.

    B) Disadvantages

    1) Limited Number of Bump Ups

There could be one or two chances to bump up rates over the maturity of the bump-up CD. Restrictions on the number of bump-up requests could lead to extra caution about the market and making wrong decisions in haste leading to lower APYs. 

    2) Limited Chance of Rate Increase in a Deficient Economy

There could be a chance of no or minor increases in rates in the economy, and funds may lock in at lower APYs. A COVID-19-related financial uncertainty or other uncertainty could force the Fed to decrease the rate to nearly zero as early as 2020. 

    3) Only Available for Longer Period

A bump-up CD locks in your funds for a longer period at variable rates. It won't be an ideal savings option for investors or savers who prefer one-year or less terms.  Bump-up CDs tend to be longer terms, such as 2 years or more.

    4) Starting a Lowe Rate Despite the Prevailing Rate High

Bump-up CD provides a lower rate than the prevailing interest rate by keeping the margin for future bump-up request meetings. 

 

But the future is uncertain it could lead to no interest rate increase. You can lose the higher rate or alternatives to bump-up CD, while picking up pump-up CD, losing the potential gain and selecting it with an opportunity cost.

    5) No Automate Rate Adjustment

You need to remain proactive and extra cautious and make requests as there is no automatic rate increase adjustment on pump-up CD.  

Alternatives to Bump-Up CD

While considering the bump-up CD, you should never miss out on the alternatives to the bump-up CD. It depends on the savings goals such as construction improvements, and major purchases. 

    1) Step-Up CDs

A step-up CD is similar to a bump-up CD. Automatically, it increases the annual percentage yield (APY)  after the set intervals over the CD maturity period. Banks decide the interest rate increase in advance and when to increase the rate.

    2) CD Laddering

Another option to bump up a CD is building a CD ladder. CD laddering is a strategy dividing funds over multiple CDs with different maturity dates, reducing the risk of missing out on the higher interest rates after placing your funds untouched for a specific period such as one-year, two-year, three-years, four-year, or five-year. 

After one year of the CD maturing, the whole amount including the interest is reinvested into a new two-year CD, keeping up to the five-year CD investment. It builds a CD ladder by taking advantage of interest rate fluctuations and maximizing the returns on savings.

    3) Stocks, Shares

Investing in shares or stocks could prove easy and one of the best money management decisions. Stocks or shares represent the ownership rights in a specific organization. It shows the fraction of ownership in a corporation. 

You can generate earnings by capital appreciation, dividend payouts, bonus shares, share split, or issuing the rights shares.

    4) Traditional CDs

A traditional CD ensures a guaranteed fixed rate for a specific period, avoiding access to funds until maturity.

Frequently Asked Questions (FAQs)

★ Can I Increase the Interest Rate on My CDs More Than Once?

A regular CD ensures a fixed rate of interest over the maturity period. A pump-up or jump-up CD has an exception and allows a one-time interest rate increase. 

Some pump-up CDs have more than one bump-up option before liquidation if funds are invested for a greater length of time such as a 2-year or 4-year bump-up CD.

★ What Is the Difference Between Bump-Up and Step-Up CDs?

Both bump-up and step-up CDs work on variable rates during the maturity period. The key difference is the approach to changing interest rates.  

The bump-up CD has one option for increasing the rate, filing a request for it. Banks, credit unions, or the issuer of step-up CD decide in advance when the interest rates are to increase at regular intervals. Normally, it is available online on the websites of financial institutions.

★ How to Get a Bump-Up CD?

Banks or credit unions issue the bump-up CD as a special savings account. you can open a bump-up savings account with them.

Conclusion

A bump-up CD is an excellent choice in case of an interest-rate-increasing economy. You can make a request for the rate increase by keeping up to date with the prevailing interest rates. The Federal Reserve rate acts as a catalyst for deciding the interest rates.

Article Sources

1. CNBC Select. "The Fed increased interest rates again — here’s why you should save more and pay off debt in response. https://www.cnbc.com/select/interest-rates-rising-saving-more-appealing-debt-more-harmful/"
2. Office of the Comptroller of the Currency. "What Are the Penalties for Withdrawing Money Early From a Certificate of Deposit (CD)? https://www.helpwithmybank.gov/help-topics/bank-accounts/certificates-of-deposit/cd-penalties.html"
3. Consumer Financial Protection Bureau. "The Interest Rate Offered for CDs (Certificates of Deposit) Is Low. Is There Anything I Can Do About That? https://www.consumerfinance.gov/ask-cfpb/the-interest-rate-offered-for-cds-certificates-of-deposit-is-low-is-there-anything-i-can-do-about-that-en-921/"
4. ALLY. Compare CDs. "Raise Your Rate CDs.,https://www.ally.com/bank/cd-rates/"
5. U.S. Department of Veterans Affairs. Opportunity Costs.,https://www.herc.research.va.gov/include/page.asp?id=opportunity-costs"
6. Federal Deposit Insurance Corp. "Your Insured Deposits, https://www.fdic.gov/resources/deposit-insurance/brochures/documents/your-insured-deposits-english.pdf" Page 3,5.
7. CFPB. "What is a Certificate of Deposit?. https://www.consumerfinance.gov/ask-cfpb/what-is-a-certificate-of-deposit-cd-en-917/"