Bump-Up CD's Overview
The CD's market has become more diversified by the introduction of CD's that present a certain degree of flexibility. Such CD's that may be more appropriate for your financial needs come at the cost of a little bit lower yield.
One of the types of CD's that allow for greater flexibility is the bump-up CD's.
The major characteristic of bump-up CD's is that you will be able to benefit from higher returns when the interest rates increase. Meanwhile you could be in the middle of time period when you are experiencing conditions of a lower rate.
How Bump-Up CD's Work
To illustrate, imagine that you have purchased a CD that has X number of years maturity. After six months have passed an increase in the interest rate offered to new CD clients is experienced. If your CD is a bump-up CD you will be given the opportunity to ask the bank to transfer to the higher interest rate for the rest of the time period.
Most of the banks tend to offer bump-up CDs with maturity of two years. However, the interest paid on these CD's is lower than the one paid on CD's that come with longer term maturities and don't include the bump-up feature.
People who invest in bump CD's are betting that the interest rates will increase in the near future. If they really rise, then fine. But the possibility that rates will not increase also exists. This probability is increased when the CD is of a short-term character.
Consider the following scenario. You have invested in a CD that has the bump feature. However, it has lower rate than the CD that has the same term but without the bump feature. Thus, under these conditions, the interest rate of the bump CD should increase more than the rate of the non-bump CD so that you take advantage of the feature and have a financial benefit.
If it takes less time for the interest rate to rise, it will manage quicker to make up for the earlier lower-rate portion that was experienced initially. Thus, good analysis of the interest rate conditions is needed before you decide to invest in a CD that has a bump feature.
Another thing you should research is the frequency with which you can bump up the rate. The number of times the bump can be triggered varies from one bank to another. This means that some banks may allow you to make a bump once, whereas others can allow you to do it twice. So, having in mind this you should carefully examine the dynamics of interest rate change and see when exactly you should make the bump.
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