Ally Bank's New Raise Your Rate CD - Better Than the 5-Year CD?
Ally Bank has just launched four new accounts and services this weekend. I did a quick overview of the Ally changes on Sunday. Yesterday, I focused on Ally's new IRAs. Today I'll focus on its new 4-year Raise Your Rate CD.
Ally Bank has long offered its 2-year Raise Your Rate CD (the rate just went down from 1.47% to 1.44% APY). It gives the customer one option to raise the rate to the existing 2-year CD rate any time during the term. No change is made to the CD maturity date.
I did a review of the 2-year Raise Your Rate CD last October. I compared it to Ally's 5-year CD, and I showed that the 5-year CD was a much better deal.
How does the new 4-year Raise Your Rate (RYR) CD compare to the 5-year CD?
First, the 4-year CD allows for two rate increases during the 4-year term. You decide when you want the rate to increase to the current 4-year rate. The increase can be requested by phone or online chat or when you're logged into your account.
The main downside of the 4-year RYR CD compared to the 5-year CD is the lower rate. Unfortunately, the rates just went down this morning. The new rates for the two CDs as of 6/21/2011 are:
- 2.34% APY 5-year CD (down from 2.37%)
- 1.99% APY 4-year RYR CD (down from 2.00%)
So is the Raise Your Rate feature worth 35 basis points?
The RYR feature may sound like a great feature when there's concern about rates shooting up in the future. However, there are reasons why it may not turn out as good as you had expected. Here are some:
- Will Ally keep its 4-year RYR CD rates competitive? If they don't, the 5-year CD would be the better option.
- When to decide to increase the rates? If you decide to make the two rate increases too late, the benefits of the RYR feature go down.
- No benefit if rates don't increase (like the last 3 years). If rates don't increase, the 5-year CD would have clearly been the better option.
If rates do shoot up in the next four years, would the RYR 4-year CD be the clear winner as compared to the 5-year CD? If the rates go up with the 5-year CD, you can close the CD and move the money into a higher-rate CD. Due to the mild early withdrawal penalty of 60 days of interest, you won't be hit hard for the early closure.
Comparing the 4-year Raise Your Rate CD with the 5-year CD
Let's say in two years, the rates for both CDs are 2.00% higher than they are today, and the rates are 3.00% higher three years from now. Below is a comparison of yields between the two CD strategies: 1) 4-year RYR CD making use of the two rate bumps, and 2) 5-year CD making use of early withdrawals and reinvesting in new 5-year CDs.
- 1.99% 4-year RYR CD
- 2.34% 5-year CD
At Year 2 assume the following new rates:
- 3.99% 4-year RYR CD
- 4.34% 5-year CD
It's decided to use your first rate bump option on the RYR CD and to close your 5-year CD and reinvest in a new 5-year CD.
Due to the penalty, the effective yield for the last two years on the 5-year CD goes down to 2.14%.
At Year 3 assume the following new rates:
- 4.99% 4-year RYR CD
- 5.34% 5-year CD
It's decided to use your second rate bump option on the RYR CD and to close your 5-year CD and reinvest in a new 5-year CD.
Due to the penalty, the effective yield for the last year on the 5-year CD goes down to 3.60%
At Year 4, the 4-year RYR CD matures. The average yield for the 4-years based on the higher rate assumptions is 3.24%.
At Year 4, the average yield for the 5-year CDs is 3.31%. If the last 5-year CD is closed at year 4, the 4-year average yield goes down to 3.08%.
It's important to note that the 5-year CD average yields shown above depend on the 60-day early withdrawal penalty holding on both new and existing CDs. I have received an assurance that Ally would not increase the EWP on existing CDs. Of course, Ally is free to change them on new CDs.
With the 4-year RYR CD, changes in the early withdrawal penalty are much less important.
I wouldn't say the 4-year RYR CD is a clear winner over the 5-year CD. It could be a slightly better deal if rates do shoot up.