Blended CD rates are a gimmick -- but a good gimmick

Red arrow bouncing up stacks of money

Banks are always looking for new ways to wrap up the same old present.

An example of this are blended CD rates.

These certificates of deposit offer an interest rate that increases at regular intervals over the term.

That's similar, but not quite the same, as "step-up CDs," which give buyers the option of increasing their return once or twice if interest rates go up.

The blended rate refers to the effective or average return a saver earns if the certificate is held to maturity.

Banks like this type of product because they can highlight the highest final rate in ads even though savers won't earn that much until the final year, or even six months, before maturity.

But they can still be good investments if you're absolutely sure you won't need to cash in early and it's paying more than traditional fixed-rate certificates.

Rule 1. Compare the blended rate with best returns you can get on traditional fixed-rate products.

It should be at least one-tenth to two-tenths of a point higher than a comparable fixed-rate certificate to make up for the fact that you're deferring much of your income until the end of the investment.

Take, for example, the blended rate being offered by TD Bank, which has 1,250 branches from Maine to Florida.

This 36-month investment starts at a 0.75% APY in year one and ends up at 1.39% APY in year three, for a blended rate of 1.05% APY.

That's not even as much as the current average return on fixed-rate 3-year certificates of about 1.5%.

It's hard to see why you'd buy a blended rate CD like that.

But Androscoggin Bank, with 13 branches in Maine, is offering a 5-year product that starts out paying 1.00% in the first year, and increases to 5.12% APY in the final year, for a blended rate of 3.05% APY.

That's almost twice the average return, and even beats the best nationally available return on 60-month fixed-rate certificates – 2.93% APY from Melrose Credit Union in New York.

Rule 2. Limit your investment to money you absolutely won't need before maturity.

Early withdrawals from blended-rate products are more costly than from traditional ones.

That's because they earn far less interest during the initial months and years than comparable fixed-rate certificates.

Bail before you get to the big returns toward the end of the term and you won't even earn the blended rate.

You must also pay an early withdrawal penalty similar to those with fixed-rate CDs – typically 3 months to 12 months worth of interest.

Rule 3. Only choose a blended-rate investment from financially sound banks.

Of course your principal will be insured at any bank insured by the Federal Deposit Insurance Corp.

But your interest rate is not.

When insolvent banks are seized by the government regulators, they are usually sold to new owners who are under no obligation to pay the CD rates promised by the failed bank.

Blended rate certificates promising sharply higher returns are obvious targets for the imposition of new, much lower rates.

Of course you have the right to withdraw you money without penalty if the rate is changed. But you're going to miss out on all the big returns you were promised in the final years or months before maturity.

So before you buy, check out how many star's the bank earns from Bankrate's "Safe and Sound" system, which evaluates banks on such factors as asset quality, profitability and liquidity.

You'll find those stars on all of the banks in our database of the best CD rates.

Or you can go here to find the Safe and Sound rating for any bank.

Think twice before buying from a bank that gets only one of five stars.

If you do your due diligence and follow these rules, you could very well find a smart deal that will earn more money than with a traditional certificate.