2025 CD Rates and Prime Rate Increases: What You Need to Know About Rising Interest Rates

In most cases, yes, CD rates tend to rise when the prime rate increases, but not always immediately.

The prime rate is the interest rate banks charge their most creditworthy commercial clients, typically tied closely to the Federal Reserve's federal funds rate. While CD rates are influenced by the fed funds rate, they are also shaped by inflation, economic conditions, competition among banks, and each institution's unique financial strategy.

When prime rates climb, it’s wise to compare CD rates across banks to find the best returns.

Key Insights

• The prime rate relates to deposit interest rates but doesn’t directly dictate CD rates in a one-to-one manner.
• Prime rates are usually higher than CD rates.
• Lending rates rise faster than deposit rates, but CD yields eventually increase.
• Some banks offer CD rates significantly above average, so shopping around is crucial.

Understanding the Prime Rate

The prime rate is a lending rate banks charge their top-tier institutional customers. Each bank sets its own prime rate, often based on the U.S. Federal Reserve’s federal funds rate — the rate banks charge each other for overnight loans. Typically, the prime rate is about three percentage points above the fed funds rate.

Both prime and CD rates are indirectly linked through the fed funds rate benchmark. However, while prime rates often rise promptly after Federal Reserve hikes, banks may delay increasing CD rates until competitive pressures mount.

For example, during the COVID-19 pandemic, many banks held excess deposits, reducing the urgency to raise CD rates despite Fed rate increases in 2022. By late 2022, some banks began offering higher CD rates to attract new deposits or maintain liquidity ratios.

Important Note

Rising prime rates won’t affect existing CDs unless they have features allowing rate adjustments.

Impact of Prime Rate Increases on CDs

Higher prime rates can boost banks' profit margins, as they often raise loan interest rates faster than deposit rates. Consequently, CD rates may lag behind prime rate hikes but generally increase over time due to deposit competition.

For example, during a period when the Fed raised rates ten times over 14 months, CD rates on 12-month deposits rose gradually but did not match prime rate increases immediately.

Top CD rates at individual banks and credit unions often exceed national averages, making it beneficial to shop around for the best deals.

How Economic Rates Influence CD Investments

CD rates tend to rise when borrowing costs increase sharply, often in response to inflation. The Federal Reserve raises its benchmark rate to curb inflation and spending, prompting banks to increase deposit rates to attract funds. Higher CD interest can help offset inflation’s impact on purchasing power.

However, inflation can still outpace CD returns. For instance, from April 2022 to April 2023, the Consumer Price Index rose by 4.9%, while average CD returns were only about 0.17%, resulting in a loss of purchasing power. Additionally, interest earned on CDs is subject to taxes.

Pro Tip

Investing in top-yield CDs rather than average ones may help you keep pace with or beat inflation, depending on current rates and inflation trends.

Choosing CD term lengths involves trade-offs: longer terms often offer higher rates but risk missing out if rates continue rising. Consider bump-up CDs or laddering strategies to maintain flexibility.

Factors Influencing CD Rates

CD rates are determined by multiple factors, including the federal funds rate, inflation levels, competition for deposits, banks’ lending needs, and profit goals.

Are CDs a Smart Investment?

CDs are low-risk investments with stable value, typically insured by the FDIC or NCUA. However, their fixed returns can be vulnerable to inflation erosion, meaning your money’s real value may decline if inflation outpaces the CD yield.

Fixed vs. Variable CD Rates

Most CDs have fixed interest rates. Some institutions offer variable-rate CDs or bump-up CDs, which allow rate increases in a rising rate environment, providing more flexibility.

Final Thoughts

Both prime and CD rates are influenced by the Federal Reserve’s benchmark federal funds rate. While prime rates adjust quickly to Fed rate changes, CD rates tend to rise more slowly and modestly. Rising rates can benefit savers seeking better returns, but inflation remains a key risk to consider.

Before committing to a long-term CD, evaluate inflation trends and interest rate forecasts to make informed investment decisions.

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