Choosing a CD term today often comes down to a grim decision: the choice between a low interest rate and a very low interest rate. And even though shorter terms represent the lower end of that scale, keeping your CD terms brief might still be the best choice for this environment.
There are two major considerations when it comes to choosing CD lengths. One is your need for liquidity, but if you don't have any short- or intermediate-term liquidity needs, then the focus shifts to the other major consideration: making an interest rate call based on current conditions. Right now, there are three conditions that suggest you may be better off keeping CD terms on the short side.
Three reasons to keep CD terms short
Looking at the current economy and the CD rate environment, here are three reasons for keeping your CD terms short:
- The economy looks like its gaining momentum. According to the Bureau of Economic Analysis, real gross domestic product grew at an annual rate of 3.0% in the fourth quarter of 2011, up from 1.8% in the second quarter. Low interest rates have been largely a function of a soft economy, but that may be changing.
- Inflation could be a problem. Inflation perked up a little in February, and more troubling, rising energy prices may put even more pressure on inflation.
- The spread between short and long rates has narrowed. According to FDIC figures, at the end of 2009 the average five-year CD paid 1.88% more than the average one-month CD. But by the end of this February, this spread was down to just 1.05%. Essentially, that means you get less of a reward for locking up your money longer.
Even if you don't have short-term liquidity needs, those are pretty good reasons for keeping CD terms short right now.
Two things you can do to get better CD rates
While this is a tough environment for CD rates, you don't have to surrender completely to settling for low rates. Here are two things you can do to get better interest rates on CDs:
- Look for low exit penalties. A key exception to the reasons for keeping your CDs short is if you can find a longer-term CD with a low penalty for early withdrawal. If the penalty is low enough, it is as good as having a shorter-term CD, but with the interest rate of a longer-term CD.
- Shop around for CD rates. Remember, even though there are some general characteristics that apply to CD rates today, those rates vary greatly from one bank to the next. Also, banks may offer specials from time to time to attract customers, giving you an opportunity to get a little better rate. Never simply roll a CD over at your current bank without looking around a little first.
There's no doubt that this is a challenging environment for CD shoppers. But those who don't adapt to these difficult conditions are likely to suffer the most from the low-rate environment.
The original article can be found at Money-Rates.com:3 reasons for keeping your CDs short