Why do banks offer absurdly low CD rates? DA member FAR asked this question in the DA discussion forum on Wednesday. That’s a good question, and it also brings up an important issue that can cost savers money if they’re not careful.
First, what is considered absurdly low? I’m sure some people may consider all CD rates in today’s environment as absurdly low. However, CD rates should be evaluated based on the current interest rate environment. One quick way I judge a CD rate is to compare it to the savings account rate at Capital One 360 (formerly ING DIRECT). This internet savings account has never been rate leader, but it has a long history of being competitive for internet savings account. It now has a rate of 0.75%. To me it doesn’t make any sense to open a CD that has a lower rate than this. That’s especially the case for long-term CDs, and that’s especially the case when the CD rate is much lower than this. In these cases, I would define the CD rate as absurdly low.
Two banks with absurdly low CD rates as defined above are iGObanking.com (a division of Flushing Savings Bank) and Bank of America. Both have 5-year CDs with a rate of only 0.35% (as of 6/14/2013). In addition, their 10-year CDs also share this same rate. Their 1-year CD rates are even lower. In this case, iGObanking.com has the highest rate of 0.15%. That’s five times higher than Bank of America’s standard 12-month CD rate of 0.03%. So if you put $10,000 into these CDs and waited a year, you would earn $15 of interest at iGObanking.com and $3 of interest at Bank of America. I think we all can agree that these rates are absurdly low.
So why do banks offer such absurdly low CD rates? One reason is that they probably have plenty of deposits to fund their loans. When banks or credit unions have more deposits than they can make use of through loans, they often invest that money in safe investments like Treasuries. So their CD rates will likely be lower than Treasury yields. Treasury yields which have recently gone up, but they’re still at historically low levels with a the 10-year Treasury note yielding 2.19% and the 5-year note yielding 1.11%.
Profiting from Those Who Are Not Careful
The absurdly low CD rates may not be just the result of the rate environment and having too much in deposits. For the case of iGObanking.com, not all of its rates are absurdly low. It’s still offering a respectable rate on its 7-year CD (1.75% APY as of 6/14/2013). That’s respectable compared to what others are offering. iGObanking.com often has a good deal on certain CD terms. However, when the deal ends, the rate plummets. It’s likely that when the “deal” CD matures, the CD will automatically be renewed into a new CD with a rate that’s no longer a deal. If the CD customers aren’t careful to close the CDs when they mature, they may be stuck with one of these absurdly low rate CDs. I wouldn’t be surprised that a sizable percentage of customers let their CDs automatically renew. In these cases, banks like iGObanking.com will do very well with CDs that cost them very little.
This shows why it’s critical not to let your CDs automatically renew without checking the new rates. In addition to the new rates, it’s also important to check the new disclosure. There may be new early withdrawal penalties or other terms that will apply to the new CD.
Banks often don’t make it easy to redeem a CD. They often make it easy to open a CD and fund it with an ACH transfer. When the CD matures, the bank may require written authorization to close the CD. Also, they may not allow an ACH transfer to receive the CD funds. DA member Pearlbrown offers some useful tips in comment #2 in this discussion forum thread about how to ensure your CD gets closed and you receive the funds.