One of the biggest disadvantages of a traditional CD is that you’re locked into a set interest for the life of your term. However, with a step-up CD, your rate automatically increases over time, so you can take advantage of rising interest rates.

Alternate name: Step-rate CD

You’ll hold a step-up CD for a set period of time, such as six months, one year, or five years. Your step-up CD will gradually increase its interest rate over time, usually on a fixed schedule. For example, U.S. Bank offers a 28-month step-up CD. Its interest rate goes up every seven months. The rates are locked in, so you know what each increase will be, as well as when they will happen.

How Does a Step-Up CD Work?

Like a regular CD, you can open a step-up CD with any bank or credit union that offers one. Once it is funded, that money gets locked away until it reaches “maturity.” This is based on how long the CD is for, such as six months or 10 years. CDs with later maturities have higher interest rates. But unlike traditional CDs, which have the same interest rate for the life of your term, step-up CDs have interest rates that incrementally increase over time. The increases are locked in ahead of time. This means you know upfront when your rate will rise and by how much. For example, TD Bank has a five-year step-up CD with rates that increase 0.05% every year. In the first year, the interest rate is 0.05%. By the fifth year, the interest rate is 0.25%.

Is a Step-Up CD Worth It?

The best way to know if a step-up CD is worth it is to compare its blended annual percentage yield (APY) to that of a traditional CD. This tells you how much interest you’ll actually earn over time. Suppose you’re trying to decide between a traditional CD that earns a 0.4% APY and a step-up CD with the following rates:

0.05% for the first seven months0.25% for the next seven months0.45% for the next seven months0.65% for the next seven months

On the surface, you may think the step-up CD is the better option. After all, its APY goes all the way up to 0.65%. However, when you average these rates together, the blended APY is only 0.35%. This is less than you would earn with the traditional CD. In this case, the step-up CD wouldn’t be worth it. An additional factor to consider is that most CDs will charge you an early withdrawal fee if you withdraw some or all of the money before the CD matures.

Step-Up CD vs. Bump-Up CD

Step-up CDs and bump-up CDs both come with rate increases, but that’s where the similarities stop. With a bump-up CD, you have to notify your bank and request a rate increase. You can typically only request an increase one time throughout the entire term. So, if your rate jumps up to 0.7% and you request an increase, you can’t request another one if it then jumps up to 1% six months later. Always read the fine print when comparing step-up CDs because they’re not all equal. For example, Southeast Bank offers what it calls a “step-up CD.” But when you read the fine print, it’s actually more like a bump-up CD. You have to initiate the rate increase, and you can only do it once.

Pros and Cons of a Step-Up CD

Pros Explained

Interest rate increases periodically: The biggest benefit of a step-up CD is that your rate increases throughout the length of your term. You also know ahead of time when it will increase and by how much, so there are no surprises.You don’t have to request any increases: Unlike bump-up CDs that require you to call your bank for a rate increase, step-up CDs are increased automatically.Safe investment: Step-up CDs are FDIC insured up to the federal limit. You’re not at risk of losing your money as you are with stock-market investments.

Cons Explained

May earn less interest than a traditional CD: A step-up CD seems like a good deal on the surface because the ending APY is often higher than what you’d earn with a regular CD. But when you average all the rates together to get the blended APY, it doesn’t always earn you more money. Not offered by all banks: Step-up CDs aren’t nearly as popular as traditional CDs. You may have to do more research to find a decent one that’s worth your time. Early withdrawal penalties usually apply: The same early withdrawal penalties that you find with a regular CD apply to step-up CDs. You need to weigh ahead of time if you can comfortably lock your money until maturity.

Alternatives to a Step-Up CD

If you’re on the fence about opening up a step-up CD, there are different options to consider.

CD Ladders

A CD ladder is a strategy of setting up multiple CDs, each with different rates and maturity dates. For example, you could open a six-month, 12-month, and 18-month CD all at once. As they begin to mature, you can decide if you want to withdraw the money, renew the CD with your current bank, or shop around for better rates. This means that every six months, you have access to some of your money.

U.S. Treasury Inflation-Protected Securities (TIPS)

U.S. Treasury Inflation-Protected Securities (TIPS) are a type of bond that rises alongside the Consumer Price Index. It’s a great alternative if you want to protect your money against rising inflation without having to lock it up in a CD.

High-Yield Savings Account

A high-yield savings account can be a good alternative to a step-up CD if you want to be able to access your money at any time. This can be a good choice if you are saving for an emergency fund, vacation, or a down payment on a house. You’ll earn a higher interest rate than you would with a checking account. You’ll also be able to make six withdrawals a month.