Variable-Rate Certificate of Deposit

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Variable-Rate Certificate of Deposit (CD)

A variable-rate certificate of deposit (CD), sometimes called a flex CD, is a time deposit offered by banks and credit unions that locks your funds for a set term while the interest rate can change over that period. These CDs combine the principal protection of a traditional CD with an interest rate that adjusts according to a specified benchmark or formula.

Key takeaways

  • Variable-rate CDs offer a fixed term with an interest rate that can rise or fall.
  • Funds are typically inaccessible without penalty until maturity.
  • They can outperform fixed-rate CDs when benchmark rates rise, but underperform if rates fall or remain low.
  • FDIC (or NCUA for credit unions) insurance generally protects deposits up to applicable limits (commonly $250,000 per depositor, per institution).
  • Variable-rate CDs are less common than fixed-rate CDs and often require a higher minimum deposit (commonly $500+).

How variable-rate CDs work

  • You deposit a sum for a defined term (e.g., 12, 24, or 36 months).
  • The interest rate is tied to a benchmark chosen by the issuing institution (examples: federal funds rate, prime rate, Treasury yields, CPI, or a market index).
  • The issuer specifies how often the rate can change (daily, monthly, quarterly, etc.) and any caps or floors that apply.
  • Interest typically compounds and is inaccessible except at maturity unless you accept an early-withdrawal penalty.

Variants and comparison

  • Bump-up (step-up) CDs: allow one or a limited number of rate increases initiated by the depositor; rates only go up, not down.
  • Fixed-rate CDs: the rate is locked for the term and will not change. Fixed-rate CDs usually offer more term options and are simpler for conservative savers.
  • No-penalty CDs: allow early withdrawal without penalty but generally pay lower rates.

Pros and cons

Pros:
* Potential to earn higher yields if benchmark rates rise.
* Principal protection and deposit insurance similar to other CDs.

Cons:
* Returns can fall if benchmark rates decline.
* May carry steep early-withdrawal penalties.
* Less widely available — may require searching smaller banks or credit unions.
* Can be outpaced by inflation, reducing real returns during high-inflation periods.

Example

Meilee opens a 12-month variable-rate CD that pays the federal funds rate minus 0.25%. At account opening, the federal funds rate is 2.50%, so her initial rate is 2.25% APY. If the federal funds rate later rises to 4.75%, Meilee’s CD rate would increase accordingly (to 4.5% in this example). If the benchmark falls instead, her CD rate would decrease. A friend who chose a 12-month fixed-rate CD at 3% would have steady returns regardless of benchmark movements.

Common questions

Q: Are variable-rate CDs insured?
A: Yes — when issued by an FDIC-insured bank (or an NCUA-insured credit union), CDs are protected up to deposit insurance limits for each depositor and account ownership category.

Q: What happens if I redeem a CD early?
A: Early withdrawal usually incurs a penalty, commonly measured in months of interest (the exact penalty varies by issuer). Some CDs allow penalty-free withdrawals but generally offer lower rates.

Q: What determines the rate changes?
A: The issuing institution sets the benchmark (e.g., federal funds rate, prime rate, Treasury yields) and defines the change frequency and any caps/floors. Terms detailing how and when the rate adjusts should be clearly disclosed in the account agreement.

When a variable-rate CD makes sense

  • You expect interest rates to rise over the CD’s term.
  • You want FDIC-protected principal but prefer the potential upside of a variable yield.
  • You can tolerate the uncertainty of fluctuating returns and potential early-withdrawal penalties.

Bottom line

Variable-rate CDs offer a middle ground between fixed-rate CDs and fully variable market instruments. They can be advantageous when benchmark interest rates rise, but they carry the risk of lower returns if benchmarks fall or remain low. Carefully review the issuer’s rate formula, change frequency, minimum deposit, and early-withdrawal penalties before investing.