Savings Bond Rates Set to Slump Soon

Certain savings bond rates are about to drop sharply -- just as rates on every other government security are rising!

If you buy the government's Series I bond before Monday, you'll earn 6.73% interest for the next six months. But if you buy the inflation-adjusted bond after Monday, it's likely that you'll earn only about 2% for the coming six months! (The final determination on the new Series I bond rate will be made by the Treasury department on Monday.)

If you'd like an explanation, I'll give it my best shot. But if you are looking to lock in high rates -- for a while, at least -- you should rush to your financial institution or go to TreasuryDirect.gov and place your order. (Individuals can purchase up to $30,000 of paper I-bonds, and an additional $30,000 of bonds electronically every year.)

And now back to that conundrum of falling savings bond rates in a period where rates ranging from fed funds to mortgages all seem to be on the rise. It's all about the way the rates on Series I savings bonds are calculated.

Savings bonds used to be the easiest way for people to put away small amounts of money and earn market rates of interest. But all that changed with Series I bonds, which were created in 1998. The rates change every six months, and the complicated interest rate formula means that current I-bond holders are earning rates that range from 6.73% to 9.40%, depending on when you bought the bonds.

That's because I-bond rates have two components. There's a fixed base rate for the life of the bond, determined at the time you buy the bond. When I-bonds were first issued in September 1998, the fixed base rate was 3.40%. And those bonds will continue to have that base rate for the 30-year life of the bond.

For the first few years, the base rate was changed every six months for new buyers, and until Nov. 1, 2001, it was at least 3%. Then it started dropping, and it is currently set at 1%.

The second part of the interest rate paid on I-bonds is based on a complicated formula. The government looks at its non-seasonally adjusted consumer price index twice during the year -- at the end of September, and again at the end of March.

It is the actual index number that is used to calculate the second portion of the I-bond interest payment. The Treasury compares the index change every six months. For example, in March 2005 the CPI stood at 193.3, but by last September (amid rising energy prices after the hurricanes), the index stood at 198.8, a pretty big jump. And that percentage jump in the index number (not in consumer prices, but in the index itself) is used to set the "interest rate factor" that is added to the promised I-bond base rate.