You may see occasional news stories explaining that the Federal Reserve raised or lowered interest rates. While the Fed, as it's often called, may seem like a faraway entity with minor importance for your day-to-day life, it plays a critical role in your finances, including interest rates for savings accounts, such as certificates of deposit (CDs) and high yield savings accounts. Here's a closer look at interest rates set by the Fed and how they connect with your savings.
What Is a CD Account?
A CD, short for certificate of deposit, is a type of savings account with a time-bound element. In exchange for depositing funds for a minimum number of months, CD accounts often offer more competitive interest rates than other savings accounts.
The main benefit is that you can lock in a competitive interest rate for an extended period. Even if interest rates fall, you get the same rate for your CD until it reaches its maturity date, commonly between a few months and five years in the future. However, if you withdraw early, you'll usually have to pay a penalty to the bank.
You may also encounter a bump-up CD, which allows you to increase your interest rate once if rates rise during the CD's term. Note that while your rate can go up, it won't decrease if the bank lowers interest rates—giving you the benefit of locking in a fixed rate with a one-time option to adjust upward if market rates improve.
As with other bank accounts, you'll generally find that CDs are protected by FDIC insurance. This guarantees you'll get your money back up to applicable limits even if the bank goes out of business, which is extremely rare.
How Fed Interest Rates Affect CD Rates
The target interest rate set by the Federal Reserve, known as the federal funds rate, is the rate at which banks lend to each other. It acts as a lever that influences various interest rates throughout the economy, including consumer savings and borrowing accounts.
For example, when the Fed raises interest rates by 0.25%, savings account interest rates and CD rates often follow, though not always at the same pace or amount. CDs offer savers a guaranteed interest rate that is locked in for a specific term.
If you sign up for a CD and the Fed lowers interest rates, your original higher rate remains locked in for the entire CD term, protecting you from declining rates. In a falling rate environment, this can be advantageous compared to other accounts where rates may decrease.
Conversely, if rates rise, you could be stuck with a lower rate on your CD, which isn't ideal. To navigate this, tracking expected rate changes at the Fed can help you decide when to opt for a CD versus a high yield savings account or even consider a strategy like CD laddering or bump-up CDs.
For bump-up CDs, you have some flexibility. If the Fed raises interest rates after you've opened a bump-up CD, you can request a one-time increase to your interest rate, giving you the chance to reap the rewards of rising rates. This option provides a middle ground, offering some protection from locking in a lower rate while still allowing you to benefit from rate hikes during your CD's term.
READ MORE: What Lower Interest Rates Mean for You
Tips to Take Advantage of Varying CD Rates
CD rates can fluctuate, sometimes without notice, so savvy individuals and households often follow a strategy to earn the most while limiting downside risk.
Create a CD ladder
A CD ladder is a strategy where you open multiple CD accounts with varying maturity dates. This approach allows you to benefit from higher interest rates offered by longer-term CDs while still maintaining access to portions of your money at regular intervals.
To implement a CD ladder, you can open CDs with varying terms all at once, such as a one-year, two-year and three-year CD. Alternatively, you can stagger your investments by opening a new CD at regular intervals, like every three months. When each CD matures, you can reinvest the funds into a new long-term CD to keep the ladder going.
Invest in long-term CDs
When rates are high and you expect them to drop, investing in long-term CDs allows you to lock in those high interest rates for a year or longer. Finding high yield CDs with top-tier interest rates can lead to earning a lot of interest over the long term.
Balance risk and returns
If you think rates may go up further, you may want to consider choosing shorter-term CDs or sticking with high yield savings accounts. This allows you to capture higher interest rates sooner rather than lock in your money at a potentially less favorable rate. Depending on your age and financial situation, you may find a mix of different account types ideal for your goals.
How To Find a Good CD Rate
To find the best CD rate, it's a good idea to shop around before committing to a long-term contract. As an online bank, Synchrony offers competitive CD rates that could beat those at traditional brick-and-mortar banks.
CD rates vary based on the type of bank or credit union, market interest rates and the bank's specific financial needs at the time. Online-only banks often feature the best interest rates for CD and savings accounts. Check out Synchrony Bank's high yield CD accounts today to find out how much you could earn.
Making the Most of Interest Rates
Interest rates trickle down to savings accounts, CDs, credit cards, home loans and more. Following the latest updates from the Federal Reserve can help you make the best short-term and long-term decisions for your saving and borrowing needs. Making a smart move on the right day could mean thousands of dollars more in the bank over time.
If you're looking for an option to lock in a competitive interest rate, check out Synchrony Bank CDs. You may find the perfect place to earn interest from your hard-earned savings.
READ MORE: How to Choose Your CD Account in an Uncertain Economy
