When is it worth it?


When banks advertise CDs, they throw “substantial penalty for early withdrawal” into the fine print. While there is a CD early withdrawal penalty, it may not meet your definition of “substantial” especially in a rising interest rate environment. With CDs rates starting to top 5% for the first time in years, it may be time to take a less-substantial penalty on an existing CD to get a more-substantial return on a new one. 

This article will look at the reason that banks charge CD penalties, the typical costs of a penalty, and when it makes sense to pay it.

Why banks charge penalties

Banks charge CD penalties for early withdrawal because the law requires it, at least under certain circumstances. Under federal law, banks generally must charge seven days interest on any CD closed within six days of opening, and they are free to charge more. That’s because CDs are designed to pay higher interest in exchange for locking up deposits, which banks in turn use to fund loans. If you aren’t meeting the agreed-on lock-up, then the bank shouldn’t have to pay the agreed-on interest. Matching the timing of assets and liabilities is a big challenge in banking and charging early withdrawal penalties is one of several ways that banks manage them. 

When you close your CD early, the charge will be taken out of principal — the amount you put into the CD — if the penalty is greater than the interest or if you had the interest sent to your checking account instead of keeping it in the CD account.

The cost of a typical penalty

Banks disclose their penalty calculations in their account disclosure statements, which are usually available online. Most banks charge quite a bit more than the minimum required seven days of interest, and they charge them on CDs far older than six days. A typical penalty is six months of interest for CDs of a year or less, and a year of interest for a CD that matures in more than a year. 

A year’s interest on a CD is the annual percentage yield multiplied by the amount invested. If you have $2,000 in a five-year CD with a 1% annual yield, a year’s interest is $20. This calculation will help you plan. The bank’s calculation may be slightly different based on the effects of compounding (interest calculated on interest), but the difference is unlikely to be more than a few cents. 

When it makes sense to pay the penalty

Although you lose interest when you cash in a CD, there are many situations in which it makes sense to pay the penalty. An obvious reason to pay the penalty is if you need the money. If you’re buying a house, have lost your job, or are sending a kid to college, taking the money that you have saved and putting it to use now may be far more valuable than the interest you would keep by waiting until the CD matures. In those circumstances, it also makes more financial sense to lose some interest on the CD than to pay a much higher interest rate on a loan.

A second good reason to pay the penalty is to move your CD into an account that pays greater interest. For example, if you have a CD that has a 1% annual percentage yield, and you can move it into a CD with a 4% annual percentage yield, then the interest you lose to the penalty will be more than offset by the amount you gain from the new CD. With CD rates at their highest level in years, many savers will be money ahead by paying the penalty.

In general:

If your account will mature in less than the time used to calculate the penalty, it may make sense to wait. For example, if you have a five-year CD maturing in three months, it makes more sense to wait the three months to roll the CD over than to lose the interest now, unless the interest you’ll earn will be greater than the penalty amount (e.g., a rate four times higher than you’re receiving now).

Avoiding penalties

Many banks offer no-penalty CDs, which allow you to roll your CD into one paying a higher rate at the same bank without a penalty. Other banks have adjustable rate CDs that automatically increase your rate if the market rate of interest goes up.

If you are closing your CD in order to move it to a new CD at a higher rate, it’s worth asking your bank if they will waive the early withdrawal penalty or if they are offering any rate-increase promotions. After all, the legally required CD early withdrawal penalty only applies to CDs open for fewer than seven days. Beyond that, a banker may have some leeway to keep your business.

Editorial Disclosure: All articles are prepared by editorial staff and contributors. Opinions expressed therein are solely those of the editorial team and have not been reviewed or approved by any advertiser. The information, including rates and fees, presented in this article is accurate as of the date of the publish. Check the lender’s website for the most current information.

This article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at [email protected].



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