Short-Term CD Rates Are Higher Than Long-Term CD Rates Right Now. Here's Why

Since early 2022, the Federal Reserve has been raising interest rates in an effort to slow the pace of inflation. And that's had both positive consequences as well as negative ones.

On a not-so-great note, the Fed's rate hikes have driven up the cost of consumer borrowing. So these days, it's pretty expensive to sign a new auto loan, personal loan, or just about any loan.

On a better note, the Fed's rate hikes have led to higher interest rates for savings accounts as well as certificates of deposit (CDs). And because CD rates are so strong, you may be willing to commit to tying up some cash for a period of time to get a guaranteed higher interest rate.

But if you go about the process of shopping for CDs, you may notice something interesting. Normally, longer-term CDs tend to offer the highest rates, but these days, that's not necessarily the case. Here's why.

When rates are expected to fall

Usually, savers are rewarded more for committing to longer-term CDs over shorter-term ones. So you'll often find that a 5-year CD, for example, is paying more generously than a 1-year CD.

That doesn't seem to be the case today. As one example, right now, at Capital One, you can lock in a 1-year CD at 4.80%. And for a 6-month CD, you can snag a guaranteed rate of 4.25%. But for a 5-year CD, you're looking at just 3.90%.

How come? The reason boils down to the fact that the Fed is expected to start cutting rates at some point next year. And once that happens, banks are likely to follow suit and start lowering their interest rates on savings accounts and CDs. Because of this, banks are only willing to commit to a certain interest rate on longer-term CDs, which explains why you might get a better rate today on a 1-year CD than a 5-year CD.

Should you open a long-term CD?

If you're looking at CDs today, your goal may be to snag the highest rate you can. So in this example, you may be inclined to open a 1-year CD over a 5-year CD.

But remember, because rates are likely to start falling, if you open a shorter-term CD, you might end up with a much lower rate by the time it comes up for renewal. With a longer-term CD, you might lock in a lower rate right now, but get to keep that rate in place at a time when banks aren't paying nearly as much.

So for example, let's say you lock in a 5-year CD at 4.10%. It may be that by this time next year, the best CD rate you can get on any product is 3.75%. So in that case, you're in good shape with your rate of 4.10%, assuming you're very confident you can afford to keep your money locked away in the bank for a full 60 months.

In fact, it could be a good time to open a 5-year CD if you want a safe way to generate a strong return for a relatively near-term goal. Let's say your child is five years away from college, for example. You may not want to invest your savings heavily in stocks because you could end up losing money over the next half-decade.

With a CD, your principal deposit is protected as long as it doesn't exceed $250,000 and your bank is FDIC insured. So you may decide that 4.10% is a good rate for an option that's risk free.

It may seem counterintuitive that you can get a better rate on a shorter-term CD right now than a longer-term one. But when you think about where rates are headed, that makes sense. And opening a longer-term CD could be a smart move right now while rates are still strong.