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Falling 5-Year CD Rates - Strategy for Savers?


Falling 5-Year CD Rates - Strategy for Savers?

This year was suppose to be the year of rising CD rates. As is typical with interest rates, they often don’t turn out as you expect.

With the global economic turmoil and the stock market volatility this year, the four Fed rate hikes that were expected for this year now appear to be very unlikely. If the global economic slowdown impacts the U.S., we may not see any additional rate hikes. In fact, the Fed could even undo its December rate hike. With central banks in Europe and Japan setting rates to negative, it’s even possible that the Fed may feel necessary to cut rates below zero if a recession hits the U.S.

All of this economic pessimism has spilled over to the banks. Several banks appear to be preparing for an economic slowdown by cutting CD rates. Also, they may have seen a surge of new deposits in January and February as scared investors moved their money into safe deposit accounts.

Investor fears are often first seen in Treasury yields. When stocks are tanking, investors typically flee to the safe assets like Treasury notes and bonds. That forces down yields. Treasury yields have plummeted this year. At the start of January, the 5-year Treasury note had a yield of 1.73%. Last Friday, the yield was at 1.24%.

With 5-year Treasury note paying only 1.24% and the 10-year Treasury note paying only 1.76%, you can see that 5-year CDs paying over 2% are attractive by comparison. Since brokers make it easy for investors to open brokered CDs, it’s typical to see brokered CD rate changes follow Treasury yield changes. The rates of the top 5-year brokered CDs offered through Vanguard has plummeted this year. In early January, the top 5-year non-callable brokered CD had a 2.30% rate. Last week it was down to 1.80%.

Most direct CD rates have held up better than the brokered CD rates. However, we have seen several CD rate cuts in the last few weeks. Below are a few of the noteworthy ones:

CD Strategy for Savers?

Should you lock into a top long-term CD now before rates fall more? Or are these recent rate declines temporary? A lot depends on the U.S. economy. If you think we’re heading into a recession, we’ll probably see a lot more rate declines. As I mentioned above, it’s not easy to predict interest rates. That’s one reason CD ladders always make sense. With CD ladders, you don’t worry about deciding the terms of your CDs based on future expectations of interest rates. You just keep renewing them into new long-term CDs with the same terms you had before.

Mild Early Withdrawal Penalties

Whether or not you choose a CD ladder approach, it always makes sense to give more weight to long-term CDs with mild early withdrawal penalties. Below are a few banks and credit unions (Barclays, Alliant Credit Union, Synchrony Bank and Ally Bank) that currently have both competitive 5-year CD rates and mild early withdrawal penalties:

If you want to compare the effective yields of CDs after the early withdrawal penalties, please refer to our CD early withdrawal penalty calculator. The risks of planning for early withdrawals have been seen at credit unions which have raised the early withdrawal penalties on existing CDs. I have more details in this blog post.

Make sure to keep a copy of the disclosure showing the early withdrawal penalty at the time you open the CD. If you need to do an early withdrawal, make sure to check the penalty to ensure it equals the penalty as described in the disclosure. DA member Cactus mentioned in the DA forum that a bank had wrongly charged him the current EWP rather than the one that was in effect for his CD. He reported the error to the bank, and they quickly gave him credit. If he hadn’t caught the bank’s mistake, he would have paid double the penalty.

Bump-Up and Add-On Features

A mild early withdrawal penalty provides some benefit if rates rise. One type of CD that helps you when rates rise is a CD that has a bump-up option. Instead of closing your CD and moving your funds into a higher-rate CD, you just use the rising-rate option to bump-up the rate to the new higher rate that’s being offered on the same CD. With these bump-up CDs, there’s always the risk that the bank won’t keep the new bump-up CD rates competitive. If rates increase, it doesn’t necessarily mean the bump-up CD rate will increase.

A mild early withdrawal penalty or a bump-up option won’t help you deal with a falling-rate environment. The one thing that can help is an add-on CD. If rates fall, you have the option of adding to your existing add-on CD rather than opening a new CD. With add-on CDs, beware of small institutions that have add-on CDs which are too generous. Typically, banks and credit unions will limit the add-on deposits by the number of deposits and the amount of the deposits. As we learned with Valor Credit Union, managers may not understand how costly an unlimited add-on CD can be.

Below are a list of CDs and rates from Ally Bank and CIT Bank which have bump-up and/or add-on features:

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Anonymous   |     |   Comment #1
Does anyone know anything?

ChrisCD   |     |   Comment #7
We have had clients that were able to exercise a bump option.  However, it takes diligent effort on the investors part.  They need to keep track of rates and make sure they have proper documentation.  Odd-term bump-ups can be especially frustrating.  If the bank just controls the offerings they make, an opportunity to bump even if rates rise, could elude  you.
Anonymous   |     |   Comment #2
I have 2 year CIT ramp-up/add-on CDs earning 1.48% so the current 1.32% is also down and I'm unlikely to have a need/chance to bump up.
Anonymous   |     |   Comment #3
Has anyone ever been able to bump up with a CD -- just curious.  I have only had one such bump CD and the bump never materialized.  
Anonymous   |     |   Comment #4
So very much depends on outcome of November's election.  Am keeping large amounts of powder dry until then.  I really have no clue as to what will happen, however:

If Trump somehow manages to win, I've seen the movie before, back starting in 1981, and I will be expecting economic activity, and inflation,  to be on the rise.  If, instead, Hillary wins, I expect another four years of an Obama-like economy.

Am not asserting one is better than the other.  But November's winner WILL influence how I invest my money.  Until there is clarity regarding November's outcome I'm making no long-term commitments.  It is not that long to wait.
eleanor   |     |   Comment #5
if trump wins, we are all doomed and rates will be low and the economy will collapse.  But hopefully, sensible American voters will elect John Kasich
Anonymous   |     |   Comment #6
I did my best to make my earlier post, #4, non-political.  I was trying, honestly as I could, to slant the post to investing only.  The two candidates I named are at present the leaders in their parties for the Presidential nomination.

You chose not to respond in kind.  Well, I can be political, too:

For the record, your boy K-Sick will not even win the upcoming Ohio Republican primary on 15 March.  Mark my words.  The dude is a massive loser, just like his acolytes.

For anyone unaware, K-Sick is currently the Governor of Ohio . . . in addition to being an unvarnished kook.  All JMHO, of course . . but I'm never wrong.
Anonymous   |     |   Comment #10
I Killery wins in November, it will even be worse!
Anonymous   |     |   Comment #11
Nothing is going to change over night.  If Trump wins, the Democrats and the "old guard" Republican establishment will be shaking in their boots.  Come on Trump!
Michael D.
Michael D.   |     |   Comment #8
I just opened a 5 year certificate last week with Wescom CU (CA) for 2.47% with 180 day penalty. If you can find that or similar and get a yield above 2.3% I would recommend going for it in case rates keep falling (which I believe they will, though may be wrong of course). By getting a 5 year w/ mild penalty, you're protected in both scenarios - if rates were to rise, you could take your money elsewhere without much pain involved. 
Anonymous   |     |   Comment #9
Patelco Credit Union (CA) also has a 60 month certificate at a Rate of 2.47% with an APY of 2.50% with 180 day penalty.
RJM   |     |   Comment #12
No CD rates are anything to get excited about. But the more stocks decline, the more I am inclined to invest rather than save.
One I bought a few years ago, SO, has a better yield than any 5 year CD. 
Given my thriftiness, I actually think I am under-invested in stocks.

In the past, I did very well. In more recent times, I havent done as well and have slowly cashed out more & more without finding places to reinvest. I think I understand risk more than I did when I was younger, but I did very well tossing risk to the side back then.
My biggest concern is healthcare insurance. The cost is outrageous and just keeps going up.
I went for almost 30 years without it.  And now that Ive had it for the last 3+ years, I feel like a patsie because I dont get anywhere near what I put in.
Anonymous   |     |   Comment #13
You don't want to "collect" what you put in to health insurance. You want the other guy to collect because they're sick and you're healthy.
Anonymous   |     |   Comment #14
Very true.  I do not wish to collect on my health insurance.  However I do not want to pay for somebody else's health insurance coverage.  No one helped my parents with health insurance coverage for us kids when our family was just scraping a living.  And my parents never asked for help. 
Anonymous   |     |   Comment #15
Don't be your brothers/sisters keeper...let them die on the streets...is that what we are reading?  The time is now not earlier when the "law of the jungle" controlled. 
Anonymous   |     |   Comment #16
The difference between past and presents is that in the past people worked for what they wanted out of life and set their priorities.  Today's generations want it all now and want it handed to them without working for it, take no personal responsibility, and purchase luxuries before they provide for their basic needs.  i.e., purchases their own health care insurance.
Anonymous   |     |   Comment #20
Single payer in five years or less will end the insurance debate.
Anonymous   |     |   Comment #22
Kemo Sabe, who is that masked man?
Bozo   |     |   Comment #17
Retail CDs still offer the best "bang for your buck". Five-year laddered retail CDs (with FDIC/NCUA insurance) are ever so much better than T-bills or bond funds. Frankly, for the retail investor, it's a no-brainer. Any yield above the CPI on a five-year CD is a gift. Treat it as such.

Fixed-income is an "anchor-to-windward". When everything goes to "heck in a hand basket", fixed-income is your ballast in stormy seas.
Anonymous   |     |   Comment #18
7 years after the housing crisis and the fed continues to bail out the big banks, who originated low quality home equity lines of credit. Look at a chart of HELOC originations (http://www.advisorperspectives.com/dshort/guest/Keith-Jurow-131216-HELOC-Resets.php), HELOCs began to soar in 2003, and following a bell curve, did not come down until 2008. 
Loan agreements made before the housing crash allowed borrowers to pay only interest for the first 10 years. That means those borrowers are reaching the "reset" point at which they begin paying principal as well as interest on outstanding debt. Estimated $52 billion in 2015, $62 billion in 2016 and $68 billion in 2017.
Those facing increased HELOC payments can refinance the home equity line and first mortgage into a single new mortgage at a fixed rate. That is if their home has increased in value or have the money for a cash in refinance.
Hence the reason for Bernanke's bond buying, which took the ten year bond to the lows in 2012, and where it is again today. It is why some "financial analysts" think long bonds will remain low until 2018, as the fed retraces the HELOC curve. While consumers borrow money, at record debt levels, just to keep up with inflation, that accompany the feds increased liquidity.
Bozo   |     |   Comment #19
As an aside, StateFarmBank, which is not exactly known as a financial institution prone to going out on a limb, offers 2.2% APY on its 5-year.
RickNP   |     |   Comment #21
Apropos of nothing except that sometimes blind luck is the best we can do: Three years ago, my local credit union, City County CU (now renamed WE CU) offered a pretty good 2.26% 60 month rate, so I opened one for $15K. A couple of months later, I had another $10,000 available and when I asked what the rate was, they told me I could just add it into my existing one. A year later, I tossed in another $20K, and last year, $40K more. So now, the far and away best 24 month option for me is to put whatever more I can into that same account where it'll earn at 2.26% and hope that deposit rates have improved when it all comes home to roost at maturity in 2018.
rich   |     |   Comment #23
You say in your note if you have laddered cd's you don't worry about rates, you just renew at the previous rate. But, the credit unions and banks don't renew at your old rate they renew at the new lower rates I thought? Is this right?
Anonymous   |     |   Comment #24
Confusing, wasn't it? The terms do not include the same interest rate which, of course, is all important to the consumer.
laste71   |     |   Comment #25
I'm sick of the banks taking advantage of the people that are trying to save while the banks are using our monies!  Something has to break this cycle!  Corruption in banking is widespread!