CDs are great investments if you want to keep money safe. Funds may be FDIC insured (where applicable), and you can earn more interest than you’ll get from a savings account. There has to be a catch, right?
There is. CDs are designed to be longer-term investments. They’re not like your checking account, which allow multiple transactions (deposits and/or withdrawals) each day.
The Reason Behind CD Penalties
The bank expects you to keep your money invested for a minimum period (like 6 months, a year, or 5 years). In return, the bank is willing to offer you a higher rate. The bank benefits from having some certainty about how long it can use your money, and you don’t have frequent transaction costs with that money.
Why can’t the bank just give you the higher rate and let you use the money whenever you feel like it? Because the bank has also made commitments with the money. The bank lends money to other customers and buys investments (like bonds, for example) that have maturities much like CDs. If you demand your money early, the bank might have to pay a “penalty” elsewhere.
How Much is a CD Penalty?
Banks will typically charge you a penalty that amounts to some of the interest you would have earned if you held the CD to maturity. You might see it quoted as “90 days of interest” for early withdrawal. There is no maximum penalty amount, so make sure you read the fine print.
A sampling of several institutions shows that you’d pay 30 to 90 days of interest on CDs that have less than a one-year term. For CDs with a term longer than a year, you can expect to pay at least 90 days worth of interest. As the term lengthens, so does the penalty. Your situation could be different, so make sure you find out before you do anything rash.
Things can get Expensive
Giving up some interest to get out of a CD doesn’t sound so bad, right? But what if you haven’t earned the interest yet? In that case, your bank might “invade the principal,” or take away some of your initial investment. That means you could walk away with less than you deposited!
How to Avoid CD Penalties
If you absolutely must cash-out early, here are some tips.
First, it never hurts to ask. If you’re at a friendly institution or smaller credit union, the staff may waive the penalty for you. If not, all they can say is “no”. I suggest cashing-out in person if you’ll go this route – the automated system (web or phone) most likely won’t do you any favors.
Also, you may qualify for a waiver for death, disability, retirement, and other life events. This is where it’s important (once again) to speak directly with a representative and find out if you can qualify for a waiver.