Managing CD Rates – Reverse Laddering Your Way to A New Home

Interest rates on longer CDs are higher than those for short-term deposits; use reverse laddering to get higher CD rates even when you are saving for a down payment bit by bit.
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By Richard Barrington

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Once you buy a home, you find yourself buying home maintenance tools that you didn’t need as an apartment-dweller, such as a ladder. Actually though, even before you buy a home, a CD ladder can help you build the down payment you’ll need for your mortgage.

Normally, laddering CD rates involves buying a series of CDs with different maturity dates. For down payment purchases, you need something you can think of as a reverse ladder: CDs purchased at different times, but with the same maturity date.

Budgeting your down payment

Because people generally save for a down payment bit-by-bit, CDs might not seem like the natural choice for these savings. However, given the size of many down payments, there should be an opportunity to take advantage of higher CD rates – and use the reverse laddering technique – if you budget your down payment savings carefully.

Consider the size of a typical down payment. Depending on your situation, you may have to put down as much as 20 percent of the purchase price in order to buy a house. According to the National Association of Realtors, the average price of a home in the U.S. is about $160,000. A 20 percent down payment on a house at that price would be $32,000.

For most people, $32,000 isn’t an amount they can scrape together in a matter of a few weeks or months. It may take a few years to save that amount – plenty of time to take advantage of higher CD rates if they use reverse laddering.

Making the most of CD rates: the reverse ladder

Here’s an example of building a reverse ladder. Chris and Tina are saving for a $32,000 down payment. They get paid every two weeks, and between them they figure they can save $500 from every paycheck. At that rate, it will take them 128 weeks, or nearly two and a half years, to accumulate $32,000.

Initially, Chris and Tina put their savings into a money market account. However, they plan their savings as a series of six-month targets. After the first six months, they have accumulated $6,500 – enough to be worth putting in a CD. They have two years left of saving their down payment, so they take this money and buy a two-year CD. After another six months, they have another $6,500, so they buy another CD – this one for one-and-a-half years, and so on.

In this way, Chris and Tina are assembling a reverse ladder – CDs with the same maturity date, but purchased at different times. In the process, they earn more than they would in a savings or money market account.

Shopping tips

If you decide to use the reverse-ladder technique for saving a down payment, don’t feel you have to be locked into the same bank for each of the CDs. Compare CD rates to get the best deal each time you open a new CD. Also, be aware of the early-withdrawal penalties, so you can know your options for taking of advantage of an opportunity a little earlier than planned.

Reverse laddering should help you save for your down payment a little more quickly – and who knows, you might have a little left over to buy a real ladder for your new home.

Frequently Asked Questions

Q: I want to build a CD ladder with equal, 1-year increments from one to five years, but I don’t have enough money saved to start it all at once. So, I figure I’ll start one CD at a time as I accumulate enough money. My question is this: Should I start at the one-year end of the ladder and add longer CDs over time, or should I start at the five-year end and work my way down the ladder?

A: If you are confident about not having to tap into these savings in the foreseeable future, you would be better off starting at the long end of the CD ladder. In fact, if you do this the right way, it could add considerably to the yield you earn.

How to create a high-yield CD ladder

When most people envision the type of CD ladder you describe, they picture having money spread into a 1-year CD, 2-year CD, 3-year CD, 4-year CD and 5-year CD. However, since you need to buy these CDs at different times in order to accumulate enough savings, you can actually use those staggered start dates to your advantage.

As you probably know, long-term CD rates are generally higher than short-term ones. So, if you make the first CD the 5-year one, right off the bat you should be earning more interest than if you started with the 1-year CD. But the advantage can go beyond that.

Suppose you start a 5-year CD and then over the next year save up enough money to start another CD to add to your ladder. By then, your 5-year CD will be maturing in four years, so at that point you could actually buy another 5-year CD, but your CDs will be starting to ladder because the two CDs will have maturity dates one year apart.

If you bought a new 5-year CD each year for the next four years, you will have built a ladder of CDs with maturity dates ranging from 1 to 5 years away. However, instead of having yields ranging from low short-term yields to high long-term yields, your CD ladder would consist entirely of higher-yielding, long-term CDs.

Then, each time a CD matures, you should be able to roll it into a new 5-year CD and preserve both the maturity structure and the high-yield orientation of your ladder.

Find the best CD rates at every rung

Another thing to note about buying these CDs at different times is that the bank offering the best CD rates may change over time. So, don’t assume you should keep getting your future CDs all at the same bank. Shop around in each case to get the best yield available at that particular time.

About Author
Richard Barrington has been a Senior Financial Analyst for MoneyRates. He has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications. Richard has over 30 years of experience in financial services. He has earned the Chartered Financial Analyst (CFA) designation from the Association of Investment Management and Research (now the “CFA Institute”).