Determining CD Rates

Determining CD Rates


Several factors determine how banks and credit unions set interest rates on CDs (certificates of deposit). Learn those factors and you can find the best rate for your savings.

To most folks, the rise and fall of interest rates on certificates of deposit (CDs) seems pretty random. You might imagine a group of bankers sitting around a table, flipping coins to decide if a new, one-year certificate of deposit should pay more or less than it did yesterday. While setting CD rates is a game of sorts, it's not one that's left entirely to chance.

Institutions that issue these financial instruments consider several factors when setting their CD rates, including:

• Length of the deposit. CD issuers maintain a rate schedule, offering different rates for longer and shorter maturities. In a normal rate environment, a longer maturity yields a higher interest rate. This encourages depositors to leave money on deposit for a longer period of time.

• Amount of the deposit. Because issuers prefer large deposits over small ones, most financial institutions will pay higher CD rates on deposits that exceed a stated amount.

• Competitive strategy and profitability. Bankers can lure in more customers by raising their interest rates just above where their competition is priced. Alternatively, some banks or credit unions may choose not to engage in competitive pricing.

Profitability for the bank or credit union is another factor influencing CD rates. Credit unions, which are not-for-profit institutions, often have lower expenses and can therefore offer higher interest rates.

• Interest rate outlook. Expected changes in interest rates might also affect CD rates. If banks and credit unions believe that market interest rates will drop, rates on longer-term certificates of deposits will move closer to those offered for short-term deposits. This is done if the issuer believes it might save money by discouraging long-term deposits. Conversely, if rates are expected to go up, long-term CDs would be priced higher to encourage depositors to lock in those funds before rates rise.

Finding the best CD rates

Finding the best rates for your savings takes a little legwork. Spend some time shopping around-visit your bank or credit union and run some searches for online banks, like ING Direct. Gather quotes and compare them based on maturity length and minimum deposit requirements. It's also a good idea to know what the investment community is saying about the outlook for interest rates, and how this might affect those being currently offered. Don't try to time the market perfectly-the experts can't even do this. Just be aware of why, for example, the short- and long-term rates might be very similar.

CD investing is a great way to take some of the risk out of your portfolio. Once you lock in your deposit, you need only sit back and wait for your interest payments, even as those bankers continue to flip their coins.