Flexible CDs stretch your savings options
By Laura Bruce • Bankrate.com

More financial institutions are offering certificates of deposit that have an element of flexibility. If you're willing to sacrifice some yield, you can find CDs with options that might better suit your financial needs.

Look for "bump-up, "liquid" or "no-penalty" CDs.

Doin' the bump
Bump-up CDs allow you to take advantage of higher returns when interest rates rise while you're stuck in the middle of a lower-rate term.

Suppose you buy a two-year CD at a given rate. If six months into the term, the bank offers its new customers a quarter-percent more, a bump-up CD gives you the option of telling the bank you want to get the higher rate for the remainder of your term.

"When we first started offering them they were very popular," says Kim Moore of First Federal Savings Bank in Frankfort, Ky. "Rates were high and they showed promise."

First Federal currently offers the bump-up option only on two-year CDs. The bank pays about a half-percent less on bump-up CDs than it pays on a slightly longer-term version -- a 30-month, traditional CD, without the bump-up option.

By purchasing a bump-up CD you're taking a gamble that rates will rise. There's always the chance they won't, especially if the feature is available on shorter-term CDs. (Each week, Bankrate surveys a panel of experts to see whether they think rates will rise. To see the latest Rate Trend Index, click here.)

If a bank offers a two-year CD with the bump-up option and a similar term CD without the option but a quarter point higher interest rate, you would want interest rates to rise significantly more than a quarter point during the two-year term if you were to take advantage of the bump-up CD.

The longer it takes interest rates to rise, the higher they'll have to go to make up for the earlier, lower-rate portion of the term. So, be sure you have realistic expectations about the interest rate environment before buying a bump-up CD.

Also, know how many times you're allowed to bump up the rate. Some banks permit just one bump; others allow two. In a rapidly rising interest rate environment you might have to do a bit of math to pick the best time to bump.

Most banks allow customers to bump up without extending the term of the CD, but some institutions may require the term to be extended.

Liquify your investment
Liquid CDs offer consumers the opportunity to withdraw money from the CD without incurring a penalty. The interest rate should be higher than the bank's money market rate, but would usually be lower than a traditional CD of the same term and minimum. Just as with any CD, the terms and conditions are set by the individual banks and can vary widely.

State Security Bank of Mankato, Minn., offers a seven-month liquid CD, with two penalty-free withdrawals if a minimum balance of $10,000 is maintained. Take more than two withdrawals or drop below the minimum balance and your interest rate will drop by almost 1 percent for the remainder of the term.

Spokeswoman Pam Pinske says this particular CD offer isn't very popular and she suspects it's the $10,000 minimum.

"It's like anything, we try to offer customers things that would benefit them. The savings accounts aren't really paying much, so some of the other options involving CDs are better."

But a $5,000, nine-month liquid CD offered at The Mechanics Bank in Richmond, Calif., is very popular, according to spokesman Garrett Lambert.

"A lot of customers like the liquidity aspect of the CD. It fits their needs and that's why we offer it. Customers who want higher yields and are willing to deposit for longer periods would probably find our other CDs more attractive."

An example of how different banks can set different rules governing CDs; at Mechanics Bank a withdrawal triggers closing out the account -- no partial withdrawals are allowed on their nine-month liquid CD. At the Mankato bank, two withdrawals are allowed and the CD stays in effect even if the balance drops below the minimum, just at a lower interest rate.

A key consideration when purchasing a liquid CD is how soon after opening the account you'll be able to make a withdrawal. Federal law requires the money stay in the account for seven days before it can be withdrawn without penalty, but banks can set the first penalty-free withdrawal for any period beyond that.

Another consideration is the number of withdrawals allowed. And, of course, you'll have to decide if the convenience of liquidity is worth whatever return you're sacrificing when compared to similar term CDs without the liquidity feature.

Fee-free transactions
The term "no-penalty CD" is sometimes substituted for bump-up or liquid CDs.

In the case of a bump-up CD, it would mean a customer could move to the higher interest rate CD without penalty, where, without that option, a customer might have to cash the CD, take the early-withdrawal penalty and buy a new CD at a higher rate.

When liquid CDs are referred to as no-penalty CDs, it simply means the ability to make a withdrawal without penalty.

While customers like the flexibility of these CDs, financial institutions like having the ability to offer CDs at less than the best market rate, at least at the outset of the term.

Banking industry analyst Todd Davenport of SNL Securities says flexible CD products are one way banks can balance assets and liabilities during times of rapidly fluctuating interest rates.

"Banks have asset liability committees. Those committees try to make sure that the loans they make and the maturities on those loans are matched up with maturities on deposits. Messing it up can cost the bank a lot of money. Anything that offers a little bit of flexibility is helpful."

While many of the larger financial institutions offer flexible CDs, you may find a wider variety of options at smaller banks. Call it the "we try harder" attitude.

"The smaller banks don't have a lot of the hedges available to large banks," says Davenport. "They can't swap pools of assets, they don't have the size and diversity to smooth out matching assets and funding, so they may need to be a bit more creative in the products they offer."

The next time you're considering a CD, compare the different features offered by financial institutions in your area. You may find it's worthwhile to take a slightly lower interest rate in exchange for greater flexibility.

-- Updated: Feb. 27, 2002