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Certificates of deposit (CDs) provide you with a valuable option to earn more on your savings. In exchange for keeping your money in a CD for a specific period, the bank or financial institution provides your account with higher interest rates than you'll typically find in a traditional savings account.
You can withdraw your money plus your earnings at the end of the CD term. Due to early withdrawal penalties, it's generally best to let your CDs mature before you withdraw your money, but there are some situations when an early withdrawal may be worth it.
What Happens if You Cash In a CD Early?
A certificate of deposit is a form of a time deposit account in which you agree to stash a minimum amount of money with a bank or financial institution for a specific term. If you cash in a CD early, before its maturity date, you'll incur an early withdrawal penalty. Penalties are typically specified as a period of interest. Not only do you forfeit future earnings, but you also must pay the equivalent of a specific period of interest—essentially a double whammy.
That can be a significant amount of money. Generally, minimum deposits for CDs range from $500 to $2,500 or more, although a few banks do not require a minimum balance.
CDs typically come with terms ranging from a few months to five years, but you may find CDs with terms as long as 10 years. Keep in mind, your interest rate will vary depending on your bank and term length. Longer terms tend to come with higher interest rates.
Consider that a traditional savings account currently earns 0.35% annual percentage yield (APY) on average, while the average 12-month CD yield is 1.36%. Financial institutions are willing to offer higher yields when you commit to holding your money in a time deposit account since they can use it for loans and other purposes. If you cash in early, though, you may forfeit a substantial part of those earnings.
How Much Is a CD Penalty?
Penalties and terms vary from bank to bank and should be disclosed when you open your CD.
Here are some examples of early withdrawal penalties with some financial institutions.
| CD Early Withdrawal Penalties | |||
|---|---|---|---|
| Bank or Financial Institution | 1-year CD | 3-year CD | 5-year CD |
| Ally | 60 days of interest | 90 days of interest | 150 days of interest |
| American Express | 270 days of interest | 270 days of interest | 540 days of interest |
| Citibank | 90 days of interest | 180 days of interest | 180 days of interest |
| Capital One 360 | 3 months of interest | 6 months of interest | 6 months of interest |
| Wells Fargo | 3 months of interest | 12 months of interest | 12 months of interest |
Before you withdraw money from your CD account, it's essential to calculate your early withdrawal penalty, which depends on these three factors:
- The penalty for your CD term
- Whether your interest compounds daily or monthly
- If the CD penalty is based on your entire balance or only the withdrawal amount
Here's the formula for calculating your penalty:
Penalty = Withdrawal Amount (or Balance Amount) × (Interest Rate/365 Days) × Number of Days' Interest
Let's say you have $5,000 in a five-year CD with a 4% APY. The CD early withdrawal penalty with your bank is 150 days' interest, and they do not allow partial withdrawals, so you'll have to withdraw your entire balance.
Plugging the numbers into the equation can help you determine how much your CD penalty will cost you; in this case, a little over $82.
$5,000 × (.04/365) × 150 = $82.19
Before opening a CD account, ensure you read and understand your financial institution's account terms.
When It May Pay to Take the Penalty
While it's advisable to hold your deposit in a CD until maturation to reap the maximum earnings, there are scenarios in which you may deem it worthy of withdrawing early and taking the penalty, such as:
- To take advantage of rising interest rates: If interest rates are substantially higher than when you first opened your CD, redirecting your deposit into a higher-earning CD may make sense. For example, if your current CD earns 2.5% and the early withdrawal penalty is 60 days of interest, it may be worth it to withdraw your deposit and place it in a CD that earns 4% interest. Before proceeding, run the numbers to ensure you'll earn more from a new CD even after paying the withdrawal penalty.
- To earn a higher return on investment: Sometimes, your money might garner a higher ROI in a different investment, even after paying the early withdrawal fee. If you have a three-year CD with $10,000 that earns 3% annually, you'll earn about $927 if you hold your money in the account through maturation. That's a good return, but if you're buying a house, moving that $10,000 and adding it to your down payment may save significantly more money on mortgage interest charges. For example, Experian's mortgage calculator reveals that a $60,000 down payment on a $300,000 home with a 30-year fixed-rate mortgage at 6% would leave you with a total principal and interest cost of $518,011. However, adding that $10,000 from your CD to your down payment could lower your principal and interest costs to $498,586. In this scenario, you'd save nearly $20,000, which makes any CD withdrawal penalty seem paltry by comparison.
- To pay off high-interest debt: If your earnings from a CD fall well short of the interest charges you pay on your debt, it may be financially worth it to use your CD money to pay off debt and pay the CD early withdrawal penalty.
- To cover a large unexpected expense: You might consider withdrawing your CD deposit if you suddenly face an expensive car repair, an unplanned medical expense or another financial emergency. If your emergency savings isn't enough to cover the expense, cashing out your CD and paying the penalty may be a better option than taking out a high-interest credit card or loan to cover the expense.
How to Avoid Early Withdrawal Penalties
The best way to avoid early withdrawal penalties is to wait until the CD's maturity date to withdraw your funds. But if you're looking for more flexibility, consider the following ways to avoid incurring an early withdrawal penalty:
- Opt for a no-penalty CD. Some banks offer CDs without penalties for early withdrawals. You'll still receive a guaranteed rate, though the APY will likely be lower than a traditional CD.
- Consider a brokered CD. Brokered CDs work like standard CDs, but you purchase them through a third party such as a brokerage. Many brokerages offer higher interest rates, longer terms and no early withdrawal penalties. Rather than withdrawing your deposit and paying a fee to the bank, you can sell your brokered CD on the secondary market.
- Create a CD ladder. Building a CD ladder is one popular way to earn guaranteed interest while still enjoying periodic access to your funds. A CD ladder is when you have multiple CDs with different maturity dates. For example, you could open up five CDs with terms that mature in successive years. Every year one of your CDs will reach its maturity date, and you can reinvest it into another CD or cash out your account funds.
- Plan for emergencies. Only deposit funds you're confident you won't need and keep the rest in a separate emergency fund. Ensure you have enough cash reserves to cover unexpected expenses so you don't have to withdraw your CD early.
Find High-Yield CDs
The Bottom Line
Most people deposit money in a CD intending to leave it in the account until its maturity date. Unfortunately, that's not always possible, especially if you experience a financial setback like a loss of income or a large unexpected expense.
As such, it pays to be prepared. Consider improving your money habits and shoring up your finances for a layoff, a recession or other financial misfortune. Planning ahead can help you avoid taking money out of your CD early and paying the CD withdrawal penalty.
Also, don't forget about your credit since a good credit score may give you more options for handling a financial emergency. Get your free credit report and credit score from Experian to get a clear view of your credit and take any necessary steps to improve your credit.