Why Open CDs Before Interest Rates Fall

Saving in a certificate of deposit (CD) is a popular way to grow your money. The key to saving in CDs is locking in a solid rate.

CD rates hinge on several factors, including how the Federal Reserve moves with rate hikes or cuts. With signs pointing to a Fed rate cut, it's important to know what that could mean for CD accounts. 

CDs Allow You to Lock In High, Long-Term Rates

If you don't know a lot about how CD rates work, here's a primer. 

The Federal Reserve sets the federal funds rate. That's the rate that banks lend money to one another overnight. The Fed can move this rate up or down to manage economic policy. 

Banks use the federal funds rate and other factors as a guide when setting rates for CDs, savings accounts and loans. Whether the rate rises or falls can directly impact your wallet. 

• Rate hikes make borrowing more expensive, but you'll typically earn more interest on savings and CD accounts
• Rate cuts make it cheaper to get a loan but you won't earn as much interest with savings accounts or CDs. 

One thing the Fed monitors when deciding whether to cut or raise rates is inflation. After soaring during the COVID-19 pandemic, inflation rates have returned to what the Fed considers to be a normal range. 

Because of that it's likely that the Fed will cut interest rates sooner, rather than later. And that means the impressive CD rates we're seeing now won't last long. 

Lock In The Highest CD Rates Before Interest Rates Crash Again

The Federal Reserve plans to continue dropping interest rates. To ensure that you continue to generate reliable returns for years to come, consider a CD now to lock in the highest available rates:

Opening a CD account before a rate cut happens can help you lock in higher rates for the long term. 

Say, for example, that you open a 12-month CD today that's earning 5.50%. You deposit $10,000 into your CD. A year from now, you'll have $10,550 to show for your savings efforts. 

Now, what if you put that money into a high-yield savings account instead? 

You might earn the same 5.50% APY to start. But if the Fed decides to cut rates you could be earning a much lower rate 12 months from now. CDs, meanwhile, offer the advantage of locking in a higher rate for the entire term. 

Tips for Building Savings with CDs

CDs have a set term and withdrawing money before that term ends could cost you some or all of the interest you've earned. Banks use early withdrawal penalties to discourage savers from pulling money out of their CD accounts prematurely. 

If you're thinking of moving money into CDs to get ahead of a Fed rate cut, you might consider building a CD ladder. 

Laddering CDs means opening multiple CD accounts with different terms and rates. For example, your ladder might look like this:

• $1,000 in a 6-month CD earning 4.20%
• $1,500 in a 9-month CD earning 4.35%
• $2,000 in a 12-month CD earning 4.80%
• $2,500 in an 18-month CD earning 5.00%

CD ladders offer flexibility since a maturity date is always around the corner. If you have a CD that's about to mature, you can pull the money out if you need it. And if you don't, you can renew the CD for a new term so it keeps earning interest. 

Here are a few things to keep in mind if you're building a CD ladder. 

• Compare rates and terms. Longer-term CDs tend to offer higher rates but that isn't always the case, since banks can offer shorter-term CDs with promotional rates. 
• Check bank policies for early withdrawals and penalties, in case you need to take money from your CD ahead of schedule. 
• Consider minimum deposit requirements and how much money you want to commit to each CD you open. 

There's no limit to the number of "rungs" you can add to your CD ladder. It ultimately depends on how much money you have to park in CDs and the number of accounts you're comfortable keeping track of. 

When CDs Reach Maturity

Once a CD reaches maturity, you can either withdraw the money and interest earned or renew it. If you renew it, the money stays in the CD and a new term begins. 

Automatic renewal

Banks can automatically renew CDs for the same term unless you specify that you want to choose a different one. Renewing for the same term doesn't guarantee that you'll get the same rate, however. 

If rates have dropped since you opened your CD then you'll likely have a lower APY for the new term. You'd have to decide if it makes sense to:

• Renew for the same term, even if it means getting a lower rate
• Choose a different term if you could get a higher rate
• Pull your money out of the CD altogether

Grace period

Banks usually give you a CD renewal grace period to decide what you want to do. The window is typically 7 to 10 days. 

Whether you should renew a CD depends largely on what's happening with interest rates and if you need the money. If you don't plan on using the money for anything right now, it could make sense to renew for a new CD term, assuming that you can get a rate you're happy with. 

On the other hand, if you need the money for something or you found a better rate with a high-yield savings account it could make sense to opt out of renewing your CD. 

Regardless of whether you prefer CD accounts or savings accounts, keeping an eye on the Fed can help you stay one step ahead of rate cuts. 

Frequently asked questions

What is a CD?

A CD or certificate of deposit is a time deposit account. When you open a CD, you deposit money and agree to leave it in your account for a set term. The money in your CD earns interest and once it matures, you can withdraw all of the money. Withdrawing money from a CD before maturity could result in a penalty. 

How is a CD different from a savings account?

CDs lock in your rate for a set term, making it easy to calculate how much interest you'll earn. Savings accounts don't do that; instead, rates can fluctuate up or down. The upside is that savings accounts let you withdraw money as needed versus requiring you to wait until the end of the maturity term. 

Is my money safe in a CD?

CDs are a safe, secure place to save, just like savings accounts. Since rates are guaranteed for the CD term, there's no risk of losing money. And assuming that you've opened your account at an FDIC-member institution your money is protected on the off chance that the bank fails. FDIC insurance covers you up to $250,000 per bank.