Questions before exercising your CD renewal
If bottom-of-the-barrel interest rates are taking a toll on your investment earnings, you may be worried about the big decision: to renew or not to renew your certificate of deposit.
Whether you’re saving for a big event, planning for retirement or simply hoping to earn some additional income, exercising the option to renew requires you to study the market and study your personal financial picture.
Before the letter from the bank arrives in the mail to alert you of your CD’s upcoming maturity, here are five crucial questions to help you reach a well-informed answer that fits your personal needs.
Have your financial objectives changed?
As your CD approaches maturity, thinking forward to your future financial needs can help determine if renewal is right for you.
“Certificates of deposit are a time deposit,” says Greg McBride, CFA, Bankrate senior financial analyst. “Before you commit the money for that length of time, you have to be reasonably certain that you can live without the money for the entire term.”
McBride says that making that determination involves revisiting the reason you initially invested in the CD or reassessing your current cash needs.
If your CD still has time to reach maturity, you can get a head start on answering the renewal question. Colleen O’Brien, vice president and branch manager of Charles Schwab & Co. in San Ramon, Calif., says that evaluating your financial situation on a regular basis is important because needs and goals often can change.
“The best place to start is with a third party to talk about your current and future goals,” O’Brien says.
If you do not have a personal financial adviser, an investment goals calculator can help you understand how long it will take to reach your goal with your CD’s renewal rate.
Does your CD come with strings attached?
A CD’s interest rate may not paint the complete financial picture.
Because some banks require a depositor to maintain a checking account to qualify for the most attractive CD rates, consumers may be subject to additional fees and yield hurdles such as monthly maintenance fees or minimum balance requirements on the accompanying checking account.
“To be able to participate in the ‘rate game,’ banks need to cover their interest rate expenses when they offer much higher rates than the competition,” O’Brien says.
O’Brien adds that if a bank pairs checking account fees with higher CD rates, the bank can recover some of its costs.
Don Taylor, assistant professor of finance at Pennsylvania State University in Brandywine, Pa., and Bankrate’s investing adviser, says that if the checking account has a minimum balance requirement, the depositor should consider the average yield on the CD plus the checking account.
Can you move into a higher interest rate?
Think outside the CD box.
With some high-yield checking accounts offering superior rates, consumers can consider alternative strategies for increasing yield. Bankrate’s 2010 High Yield Checking Study shows that consumers can take advantage of increased rates with a few additional restrictions and balance caps.
However, McBride warns that certain depositors should not break with CDs.
“For an investor who is renewing a CD that’s part of a CD ladder, it’s unwise to disrupt that ladder based on interest rates,” McBride says.
For a comprehensive comparison of earnings potential based on different interest rates, you can use a savings rate comparison calculator to estimate your earnings among a range of banking products.
Out with the old, in with the new?
While you may have locked in a high interest rate five years ago, McBride advises that CDs renew at current market rates. At the local branch level, high-value investors may be able to negotiate for slightly higher interest rates when renewing a CD.
Being aware of an upcoming renewal is crucial.
“If you’re not paying attention and that CD renews for another three years at a low rate, you may leave yourself in a bad place,” McBride says.
Taylor agrees and advises that depositors be aware of the renewal window in advance of the bank’s notification. When the time arrives, he suggests comparing the renewal rate against what’s available at other institutions.
To estimate your CD’s earnings before you renew, use a bank CD calculator to determine your yield based on new rates and the frequency of interest compounding.
Can you afford to play the waiting game?
Because CD rates are so low in the current market, investors may be afraid to commit to a five-year CD.
“Rates aren’t going to go up overnight,” Taylor says.
Still, there are strategies for CD investment that can help a depositor take advantage of above-average CD rates while increasing liquidity. Taylor recommends considering a stepladder or barbell approach instead of committing to a CD ladder that extends for five years.
These two approaches involve investing in shorter maturities with the option to consider long-term maturities in the future. McBride also suggests considering alternatives options such as liquid CDs, bump-up CDs and step-up CDs — CD alternatives that offer a chance at higher yields later.
Regardless of whether or not you decide to renew your CD, the renewal period is your time to test the market.
“When your CD is due for renewal, this is your shot at free agency,” McBride says. “You get to shop around and see where you can get the best return.”