Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Variable-Rate Certificate of Deposit

What it is:

A variable-rate certificate of deposit (CD) is a CD with an interest rate that can change.

How it works (Example):

A CD is an investment whereby the investor deposits a certain amount of money with a bank or credit union, which agrees to pay interest on that deposit for the duration of the deposit. Generally, the depositor cannot access the investment again until the term of the CD is up, which can be anywhere from one month to several years long.

Most investors opt for fixed-rate CDs, which pay a flat rate of interest. However, some institutions also offer variable-rate CDs, which offer interest rates based on Treasury bills, market indexes, the prime rate, or other market rates. Often, the interest an institution will pay on a variable-rate CD equals the percentage change in the associated index or rate over the duration of the CD.

For example, if the CD is based on the changes in the prime rate and the prime rate increases from 5% to 8% over the duration of the CD, the difference is the interest rate on the variable rate CD -- in this case, the difference in the prime rate is 3%, which is what the investor will earn.

Why it Matters:

CDs are one of the most conservative investments there are, and the interest rates on them tend to be very low. Variable-rate CDs offer investors the opportunity to receive higher returns if interest rates in other areas of the markets go up. Of course, the opposite is true: If rates go down, the interest rate on a variable CD can also decrease.