A variable-rate certificate of deposit (CD) is a type of savings product offered by banks and credit unions. Like a traditional CD, you agree to leave your money deposited for a specific period of time. The key difference is that the interest rate on a variable-rate CD can change while your money is locked in.
Instead of earning the same rate from start to finish, your return may go up or down depending on what’s happening in the broader economy. This feature can make variable-rate CDs appealing in certain situations, especially when interest rates are expected to rise.
Understanding Variable-Rate CDs in Simple Terms
When you open a variable-rate CD, the bank gives you a starting interest rate and explains how that rate might change over time. The adjustments usually follow a specific rule, such as changes in inflation, government interest rates, or other widely used financial benchmarks.
Some common factors that influence variable-rate CDs include:
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Inflation measures like the Consumer Price Index (CPI)
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The prime lending rate
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Treasury bill rates
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Major stock market indexes
The bank will also outline how often the rate can change, whether there’s a minimum or maximum rate, and what happens when the CD reaches maturity.
By comparison, a fixed-rate CD keeps the same interest rate for the entire term, no matter what happens in the market. That predictability is what many savers like but it also means you won’t benefit if rates go up later.
Variable-rate CDs are sometimes marketed under names like step-up CDs, bonus-rate CDs, or multi-step CDs.
A Real-Life Example
Imagine you have $10,000 saved for a home down payment you plan to use in about three years. You’re comparing CD options at your bank.
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A fixed-rate CD offers a steady 0.5% annual return for two years.
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A variable-rate CD starts at the same 0.5%, but the rate can increase if market rates rise.
If interest rates improve during your CD term, the variable-rate option might climb to 0.7%, helping you earn more than the fixed-rate CD. But if rates fall, your return could drop to 0.3%, leaving you with less interest than you would’ve earned with the fixed-rate option.
This trade-off potential upside with some uncertainty is the core decision when choosing a variable-rate CD.
How Variable-Rate CDs Work in Practice
Opening a variable-rate CD is straightforward. You deposit a set amount of money and agree not to withdraw it for a certain length of time, such as one or two years. In exchange, the bank pays interest that can change according to the rules in the CD agreement.
Even though the rate may fluctuate, these CDs are typically FDIC-insured, meaning your principal is protected (up to legal limits) if the bank fails.
However, the fine print matters. Different banks handle things differently, including:
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Early withdrawal penalties
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Whether the CD renews automatically at maturity
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Whether you can add money or withdraw funds without penalties
For example, some banks allow a one-time penalty-free withdrawal or let you add extra deposits over time. Others offer a “floor rate,” meaning your interest rate won’t fall below a certain minimum even if market rates drop.
There are also CDs that only move in one direction: up. These products allow your rate to increase at set intervals but never decrease.
Be Careful With Automatic Renewals
Many CDs automatically roll over into a new CD when the term ends unless you take action. While convenient, this can sometimes work against you.
If rates have changed since you opened the original CD, the renewed CD might come with a lower interest rate. That’s why it’s smart to compare current CD rates at several banks before letting your money roll over automatically.
Alternatives to a Variable-Rate CD
Fixed-rate CDs remain the most popular choice for savers who value certainty. They’re especially useful when interest rates are high and you want to lock in a strong return.
If rates are low, though, you might also want to consider:
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High-yield savings accounts
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Money market accounts
These accounts usually offer variable interest rates similar to variable-rate CDs, but with much more flexibility. You can typically withdraw your money at any time without paying early withdrawal penalties.
For short-term goals or emergency savings, these alternatives may make more sense than committing funds to a CD.
Please take a look at this as well:
Can a Certificate of Deposit Help You Build Credit?
