What is a step-up CD, and how does it work?

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Opening a CD usually means locking in a fixed interest rate for the entire term. With a step-up CD, on the other hand, the rate automatically increases at predetermined intervals, giving you the opportunity to earn more as time goes on. And while that might sound like an obvious benefit, step-up CDs come with a few trade-offs to consider before opening one.

Step-up CDs have predetermined rate increases that kick in at set intervals. You can typically expect the rate on a step-up CD to start at around 0.05%, increase by up to 0.20% every seven to 10 months, and mature within 30 months.

If you want to compare rates between step-up CDs and traditional CDs, look at the "composite APY" or "blended APY" on the step-up CD. This figure shows you the average rate you'll earn if you leave your money in the account until it matures.

Right now, step-up composite rates range from 0.10% to 0.35% APY. That's considerably lower than today's best CD rates , which hover around 4% APY.

As if that isn't enough reason to pass on step-up CDs, consider that some of these accounts are callable. That means the bank can close the account before it matures and then give you back your deposit and interest. A callable CD is most likely to be closed if market rates fall below what you're earning on the account.

Like step-up CDs, bump-up CD rates can increase. However, step-up rates adjust multiple times while bump-up rates usually increase just once, and only if the issuing bank raises its available rates. If that happens, you have to request an adjustment from the issuer. As the investor, that means you'll need to try and time the market to ensure you get the biggest increase possible.

Both types of CDs are difficult to find, and both offer lower rates than traditional CDs. However, bump-up CD rates tend to be more competitive than step-up CD rates.

Step-up CDs are not common. Here are a few examples of step-up CDs available today:

Citibank Step Up CD : This 30-month CD has a $500 minimum deposit, starts at a rate of 0.05% and adjusts up to a high of 0.15%.

US Bank Step Up CD : Rates increase every seven months on this 28-month CD, and you'll earn a composite rate of 0.35% APY.

SouthPoint Financial Credit Union : Terms of 24 and 36 month are available with a $1,000 minimum opening deposit. Both terms earn 3.55% APY.

Step-up CDs are generally not worth investing in. The rates on these CDs are typically nowhere near competitive, even when you figure in the multiple increases over an account term. With composite APY around 0.35% (and that's on the high end), your money can earn a lot more in a traditional CD, a high-yield savings account (HYSA), and even in some checking accounts.

You won't have any trouble beating the interest rate on a step-up CD. Several other fixed-rate investments and even some bank accounts pay higher returns.

For a short-term deposit account that pays a higher rate than a step-up CD, consider investing in a traditional CD.

How much more could you earn by going this route? Frankly, a lot more. For example, a $10,000 deposit will only earn $70 in interest in a 24-month step-up CD with a composite rate of 0.35% APY. However, that same $10,000 deposit would earn $816 in interest in a traditional 24-month CD with 4% APY.

Another low-risk investment that will pay more than a step-up CD is a Treasury bill. With T-bills, the rate of return is guaranteed up-front, and you can choose terms ranging from four to 52 weeks, with rates of about 3.75% to 4.13%, depending on the term length.

Unlike step-up CDs, high-yield savings accounts (HYSA) have variable rates, which means they can go up or down at any time. That said, many HYSAs are still delivering rates over 4% APY.

For another bank account that can outperform a step-up CD, try a money market account (MMA). Like HYSAs, the rates on MMAs can drop at any time, but the current national average (0.63%) is nearly twice as high as the composite rate on most step-up CDs, and many banks are still offering up to 4%.

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