Exploring the Factors Behind the Fluctuating CD Rates
Interest rates on certificates of deposit (CDs) change frequently. What can you expect from CD rates in 2024? Here’s a look at current CD rates and why they vary.
**What Are CDs and How Do They Work?**
CDs are savings tools that earn interest on money invested for a set period. Unlike regular savings accounts, you must leave the money in your CD account for the entire term, or you might face a penalty for early withdrawal.
Most CDs have fixed interest rates that you lock in when you invest, but some have variable rates. This means if interest rates rise after you’ve invested, you could potentially earn more on your investment.
The principal and term are key factors when investing in CDs. The principal is the amount you deposit when you open your CD account. The term is the length of time you agree to leave the money in the account. Terms can range from six months to several years. After the maturity date, you can withdraw your money without penalty.
**What Are Average CD Rates?**
In September 2023, the average interest rate on a one-year CD was 1.76%, and a 60-month CD was 1.38%, according to the Federal Deposit Insurance Corporation. Since then, many financial institutions have increased CD interest rates. For instance, as of April 2024, Capital One’s 12-month CD rate is 5.00% APY, and its 60-month CD is 3.90% APY.
**What Causes CD Rates to Vary?**
CD rates can vary for several reasons:
**The Federal Funds Rate**
The Federal Reserve sets the federal funds rate, which affects how much financial institutions charge to borrow and lend money. This rate influences CD interest rates, also known as annual percentage yields (APYs). When federal interest rates increase, CD APYs usually follow, though it may take weeks or months to see the changes.
**Inflation**
CD rates tend to rise with inflation. To combat inflation, the Federal Reserve often increases the federal funds rate. Since CD interest rates are linked to this rate, they generally rise when the Fed’s benchmark rate goes up.
**Recession**
During recessions, CD rates have historically tracked the federal funds rate. The Federal Reserve typically lowers interest rates during recessions to boost economic growth and reduce unemployment. For example, in 2022, interest rates steadily increased after the Federal Reserve raised short-term borrowing costs from 0% to 4.5% to curb inflation.
**Competition Among Financial Institutions**
Banks know that CDs represent short-term relationships, often just six or 12 months. To retain customers when CDs mature, banks and credit unions may adjust their CD strategies, considering factors like the federal reserve rate, higher interest rates, and inflation. This competition can lead to rate wars.
**When Should You Buy a CD?**
CDs are a safe and reliable way to save money and earn interest. Since you typically lock in your interest rate when you open a CD account, timing is crucial. Consider these factors when deciding the right time to open a CD:
**What are Current Interest Rates?**
It’s beneficial to open a fixed CD account when interest rates are high. If rates decrease during your CD term, you keep your higher rate. Currently, CD rates are high, averaging around 5.50% APY, making it a good time to get a CD if you qualify.
**When Will You Need the Funds?**
Before investing in a CD, determine when you’ll need to access your money. Long-term CDs usually offer higher interest rates than short-term options. CD funds and interest rates are locked until their maturity date, so choose your term length based on your future financial needs.