Are Higher CD Rates a Good Thing? Here's the Downside

A lot of people I know are happy with today's CD rates. And I totally get it. Who wouldn't want a chance to score a virtually risk-free 5% return on a pile of cash?

But while higher CD rates might seem like a good thing, there's a flipside everyone needs to acknowledge. And it's important to be very careful when opening a new CD because of that flipside.

Why higher CD rates are a problem

Banking higher-ups didn't just wake up one morning and say, "Hey, let's throw savers a bone and raise CD rates so everyone can earn more on their money." What happened is that the Federal Reserve spent much of 2022 and 2023 raising interest rates in an attempt to slow the pace of inflation.

When we talk about the Fed raising rates, it's not CD rates they specifically took action on. Rather, the Fed oversees the federal funds rate, which is the rate banks charge each other for overnight loans. But as that benchmark interest rate rises, other consumer rates tend to follow its lead. And that explains why CD rates are elevated.

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Now, the problem: It's not just CD rates and savings account rates that are high. Borrowing rates are up, too.

These days, it's more expensive to sign a mortgage, finance a car purchase, or take out a personal loan than it was a few years ago. Credit card balances have also gotten more expensive to carry. And as long as CD rates remain elevated, borrowing rates will remain high, too. So while consumers with money in the bank are benefiting from today's rates, those who owe money are in the opposite boat. And for those with CDs and loans at the same time, it's sort of a wash.

Think carefully before opening a CD

You may be eager to open a CD while rates are nice and high. And that's not necessarily a bad idea, especially since the Fed could start cutting rates pretty soon. But before you tie up money in a CD, think about your financial situation. Ask yourself:

• Is my emergency fund in good shape, and do I have enough money to cover at least three months of essential expenses if needed?
• Do I think there's a car or home repair in my near future?
• Am I anticipating another large expense, like having to travel for a wedding?

Remember, closing a CD early generally results in an early withdrawal penalty. So once you put money into a CD, it's best to keep it there. Make sure you can afford to give up access to your money for the duration of your CD. And definitely assess your borrowing needs.

As we just discussed, now is not a good time to borrow. And it's silly to put yourself in a position where you might, for example, have to sign a personal loan at a rate of 9% because you stuck your spare cash into a CD paying 5%.

You may also want to set up a CD ladder, rather than putting all of your money into a single CD. This way, portions of your cash will free up at different times during the year, making it less likely that you'll have to borrow to cover a surprise expense.