A Variable Rate or Indexed Rate CD is an Absurd Product for Depositors

We've been fielding a lot of questions from readers about "variable CDs", "flexible rate CDs" or "indexed CDs". It seems that several banks and credit unions have been heavily promoting these products, and we have learned that they may now be appearing on the top of rate tables on some websites.

Make no mistake, a variable rate Certificate of Deposit (also perhaps called a flexible rate CD or an indexed Certificate of Deposit) is an absurd product for anyone to purchase and should be avoided at all costs.

The entire purpose of a Certificate of Deposit, versus a savings or money market account, is to lock in an interest rate over a period of time. At a time like the present where interest rates are at multi-year highs, depositors are wise to lock in some of their money at a guaranteed interest rate for 2, 3, 4 or 5 years in order to guard against the possibility that interest rates reverse course and come back down quickly. (Since Certificates of Deposit carry an early withdrawal penalty, depositors should not put money in a CD that they may need before maturity, especially since banks may have terms allowing them to refuse early withdrawals).

While the very nature of a CD is to lock in an interest rate and guard against falling rates, a variable CD is precisely designed by the issuing bank not to achieve that goal, but nonetheless to lock in the depositor.

I looked at the 3-year variable CD product being offered by Valley Bank. This product is geared to pay 0.10% APY above the current upper limit of the Fed Funds rate (currently 5.50%). If the Fed Funds rate falls, you will be earning less than the advertised rate after the next reset. Equally vulnerable is a Flex Index CD offered by Merchants Bank of Indiana which is tied to a 2.75% margin below the Prime Rate.

Compare CD rates here.

At the same time as we caution against variable CDs, we recognize that variable savings accounts do not bear the same risk. Ivy Bank, for example, offers an Indexed Savings account that resets monthly based on the 1-Month US Treasury rate and that currently yields 5.66% APY. Savings accounts like Ivy Bank's offer depositors the advantage of higher savings rates, but depositors aren not locked into a long-term CD with the prospect of lower rates should the index fall.

Compare savings rates here.

Bottom line: We do not list variable rate, indexed rate or flexible rate CDs on BestCashCow, and we strongly encourage depositors to consider fully the risks of these products before investing in them.