Certificates of deposit or CDs are great investment vehicles for investors searching for
a low risk investment, but higher rate of return than their monies sitting in a savings account. CDs are designed to be long term investments and early withdrawal can result in penalties from the issuing institution.
Why is there a penalty?
The banks or institution that provided the CD account believes that you will leave your monies for a minimum time period as outlined in the term of your CD. In return for leaving your money for a specified term you receive a higher rate of interest than a savings account. The bank believes that when a CD is issued they will receive use of your money for the term of the CD.
Banks rely on certificate of deposit moneys being there because they have made commitments for the money. They loan the money to other customers in the form of loans or they invest the money to make more money. Banks will typically invest in bonds with the resources they receive from CDs. Therefore, if you want your money from a CD early, the bank may also have to pay a penalty for their investments or lose money the same as you will for early withdrawal before the term date.
How much is a penalty?
A CD penalty can vary depending upon the lending institution. Most banks will typically have an early withdrawal penalty that is the same amount of interest you would have received if the CD was left until the maturity date. Many will quote the early withdrawal penalty as “the same as 90 days of interest”. By law there is no maximum penalty amount. Therefore, it is extremely important that an investor read and understand the fine print of their CD before they invest.
If you really need your funds, giving up some interest doesn’t sound that bad. However, if you haven’t earned any interest when you decide to cash out your CD you may find yourself letting some of your principal go. This is one of the more extreme cases of penalties and what your exact penalty will be depends upon the lender and the CD.
Can I avoid penalties?
If you must cash out your CD these are some tips to follow;
- It won’t hurt to ask your lender about early cash out and it something can be done to lessen your penalty
- Read the details of your CD
- Ladder your CDs. Have different term or maturity dates for several CDs instead of investing in one large CD.
Some institutions will include waivers in the CD language. Therefore, in the case of death, disability or several other life events no penalty is assessed. Visit with your lender to find out if a waiver is included and qualifies for your individual situation.