December Fed Rate Hike: What It Means for CDs

Federal Reserve rate hikes, such as Wednesday's increase, can result in better annual percentage yields on certificates of deposit, or CDs. APYs on long-term CDs — often called share certificates by credit unions — have exceeded 3% at many online banks after the Fed's last few hikes.

Here’s a look at what the most recent rate increase means for CDs.

» Looking for higher returns? Here's where to find the best CD rates this month.

Seek out higher rates

CDs are a great tool for growing savings over a set time period. The longer a CD’s term, the higher the rate; most financial institutions offer terms of up to five years. In recent years, CDs with five-year terms have had average APYs well below 1%. But after the last few Fed rate hikes, a number of online banks and credit unions are now offering CDs with yields above 3%.

Although Fed rate hikes don’t cause bank rates to skyrocket overnight, they can encourage financial institutions to gradually increase their APYs. Why? Banks want to remain competitive and attract potential customers. If a few of your bank's competitors start increasing rates, yours will likely feel pressure to do the same. (Rate hikes also affect regular savings accounts; check out our best high-yield online savings accounts.)

You’ll pay an early-withdrawal fee if you close a CD before the end of its term, also known as its maturity date, and move the money to another institution with better rates. The penalties you’ll incur might nullify any gains. You could, however, open a new CD at another financial institution.

» To understand the essentials, see our rate hike Q&A

Ask for your bump up if rates increase

Some financial institutions offer bump-up CDs, which let you request a rate increase if your bank's rates go up. In most cases, you can exercise this option only once during the term of your certificate. These types of CDs typically have lower interest rates than fixed-rate certificates, and many carry steeper minimum deposit requirements.

Another option: step-up certificates

If you want a savings product that functions much like a bump-up CD but with more predictable rate increases, consider a step-up CD. These have interest rates that automatically increase at specific intervals. With a 28-month step-up CD, for example, you might start with a low APY, but your rate will rise every seven months.

Again, initial interest rates on these products tend to be low, and some of these CDs and share certificates are "callable." That means you might never see the rate boost because the issuer might redeem yours before it matures.

Watch CD rates

CDs can be a great way to set aside money for the future. And although each individual Fed rate hike might not lead to dramatic changes, it's still a good idea to monitor your bank or credit union’s response and compare it with those of other banks and credit unions.