How Do Banks Set CD Rates? 

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A certificate of deposit (CD) can be a smart choice if you need a place to grow your cash for short- to mid-term savings goals. CDs could be a good fit to put away money for an upcoming vacation, event, down payment, home improvement project, and much more. Plus, these low-risk deposit accounts are a more attractive option for savers than they have been in years, thanks to rising interest rates.

If you’re considering using CDs as part of your overall savings strategy, it’s helpful to understand how banks set CD rates (and rates for other types of deposit accounts as well). A deeper knowledge of why interest rates fluctuate can put you in a better position to earn more interest on your savings.

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Factors That Can Impact Your CD Interest Rate

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When you deposit cash into a certificate of deposit, you agree to leave your money in the account for a specified period of time, known as the CD’s term. Unlike other deposit accounts (like savings accounts, checking accounts, or money market accounts), taking cash out of a CD before your account reaches maturity could trigger an early withdrawal penalty.

Not having access to your cash could be a bit of an inconvenience. So if you’re making this concession, it makes sense that you’d want to search for the best CD rates available when you open a new CDaccount with a bank or credit union.

Here are some of the factors that determine the interest rates — also known as the annual percentage yields (APYs) — that different financial institutions offer their customers on CDs.

The Economy

When inflation soars as it has in recent months, the Federal Reserve often steps in and raises the federal funds rate to try to bring rising prices back under control. The federal funds rate doesn’t have a direct effect on CD interest rates. However, it does tend to influence the APYs that banks and credit unions pay out to their customers for CDs and other deposit accounts. The federal funds rate can also play a role in how much lenders charge consumers to borrow money on credit cards and loans.

When inflation is low, interest rates tend to remain on the low side. But when inflation is high, and the Federal Reserve hikes the federal funds rate over and over again, as it has since early 2022, CD interest rates and other types of interest rates begin to creep upward as well.

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CD Term

In addition to economic factors, the length of time you choose to lock away your savings (aka your CD’s term) can also play a meaningful role in the amount of interest you earn from a CD. Banks usually offer different interest rates for different CD terms (e.g., 6-month CDs, 12-month CDs, 18-month CDs, etc.).

Long-term CDs often feature higher interest rates than short-term CDs. But that rule only applies to a certain extent.

It’s common for the best online banks to offer CD rates that exceed the national average — often to a significant degree.

Balance

Some banks may set different CD rates based on the amount of money a customer deposits with the financial institution. So, you might be eligible to receive a higher APY on your savings if you open a CD with a minimum deposit that’s high enough to satisfy the bank or credit union’s eligibility requirements. It’s important to consider any minimum deposit requirements, including minimum requirements to qualify for higher APYs, when shopping around for the right CD and determining how much to save in CDs.

Special Features

Some banks offer CDs that come with special features. A no-penalty CD, for example, allows you to withdraw cash from your account before the maturity date without paying a penalty (though certain restrictions may apply).

A bump-up CD is another example of a CD that has special features. With a bump-up CD, you may have the option to increase or “bump up” to a higher interest rate before the end of your term if rates rise and the bank begins to offer higher APYs to new customers.

If you’re considering a CD with special features, it’s important to read the fine print and compare the account to a standard CD and offers from multiple financial institutions. Banks often set the interest rates on specialty CDs lower compared to traditional CDs because there may be added risk involved for the financial institution.

Other Factors to Consider

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The amount of interest you can earn on a CD is not only influenced by the APY a bank offers you. There are other important factors to consider as well.

Compounding Interest

When you’re shopping around for the best CD for your savings needs, pay attention to how often your interest will compound. CDs typically compound either daily or monthly. The more often your interest compounds, the faster your money is able to grow over time.

Fixed vs. Variable Interest

Most CDs offer fixed interest rates which makes these accounts a low-risk way to earn more money on your savings. However, it is possible to find variable-rate CDs with interest rates that can fluctuate up and down based on a variety of factors. Variable-rate CDs (also called flexible-rate CDs) could be beneficial if interest rates rise, but there’s also a risk you could miss out on potential earnings if rates fall before your term ends.

Early Withdrawal Penalty

Another detail to consider before you open a CD is a bank’s policy regarding early withdrawals. In general, it’s only a good idea to open a CD if you’re relatively certain you won’t need to access the funds until after its maturity date. But it’s wise to understand what the penalty would be if disaster strikes and you need to tap into your cash before your CD’s term ends. Some banks have harsher early withdrawal penalties than others. So, reviewing the fine print ahead of time is important.

Bottom Line

As a customer, you can’t control how a bank sets its CD rate, nor the terms and conditions of these unique deposit accounts. However, you do get to decide which financial institution to trust with your business.