Should I break my CD for a higher interest rate?
Paying an early withdrawal penalty could also make sense if your CD is earning considerably less than current interest rates. For example, if you have a long-term CD earning a 2% APY, and new CDs offer APYs in the 5% range, you should consider cashing out your long-term CD as it could mean earning 3% more on your cash.
Getting a CD when rates are low and breaking it when rates are high might be an opportunity to benefit from a higher-rate CD and earn you more than you would gain otherwise. A savings account is a place where you can store money securely while earning interest.
Certificates of deposit (CDs) can be closed when they reach their maturity date or before if necessary. If you decide to close a CD before it matures, you generally have to pay a penalty.
Standard CDs are insured by the Federal Deposit Insurance Corp. (FDIC) for up to $250,000, so they cannot lose money. However, some CDs that are not FDIC-insured may carry greater risk, and there may be risks that come from rising inflation or interest rates.
Banks and credit unions often charge an early withdrawal penalty for taking funds from a CD ahead of its maturity date. This penalty can be a flat fee or a percentage of the interest earned. In some cases, it could even be all the interest earned, negating your efforts to use a CD for savings.
One way you can lose money in a CD is by withdrawing your funds before the term ends. Most CDs have early withdrawal penalties, which can be steep depending on the length of the term and the amount of your deposit.
The early withdrawal penalty for your CD depends on your bank's policies and also likely depends on the maturity term of the CD. Typically, the early withdrawal penalty for a CD is equal to a few months' worth of interest, and longer-maturity CDs generally have harsher penalties than shorter-term ones.
Top Nationwide Rate (APY) | Balance at Maturity | |
---|---|---|
6 months | 5.76% | $ 10,288 |
1 year | 6.18% | $ 10,618 |
18 months | 5.80% | $ 10,887 |
2 year | 5.60% | $ 11,151 |
The risk of having a CD is very low. Unlike how the stock market or a Roth IRA can lose money, you typically cannot lose money in a CD. There is actually no risk the account owner incurs unless you withdraw money before the account reaches maturity.
For instance, say a CD charges a penalty of 180 days of interest. If you make a withdrawal three months after you opened the CD, you'll forfeit all of the interest you've earned and pay the rest of the fee out of the principal you deposited. Here are some examples of standard CD early withdrawal penalties.
Is it better to have one CD or multiple?
Use Multiple CDs to Manage Interest Rates
Multiple CDs can help you capitalize on interest rate changes if you believe CD rates will change over time. You might put some cash into a higher-rate 6-month CD and the remainder into a 24-month bump-up CD that allows you to take advantage of CD rate increases over time.
The decision to open a CD now or wait depends on many factors, including interest rates, when you'll need to access the funds and the state of your emergency fund. In general, when rates are high — as they are now — opening a CD allows you to maximize your earnings even if rates go down in the future.
You could lose out on growth
The nice thing about CDs is that you don't risk losing out on principal the same way you do by investing your money. But instead, you face another risk -- not meeting your financial goals in the long run due to limiting your money's growth.
Limited liquidity: A CD is a time-bound investment. You'll likely face a penalty if you need to withdraw your money before the maturity date. This can be a few months' interest or even bite into your principal, depending on the CD's terms. As a result, they're not ideal for those who need quick access to their funds.
A one-year CD typically offers a higher interest rate than shorter-term CDs, such as three-month CDs and six-month CDs. Offers higher interest rates than traditional savings accounts.
CDs offer higher interest rates than traditional savings accounts, guaranteed returns and a safe place to keep your money. But it can be costly to withdraw funds early, and CDs have less long-term earning potential than certain other investments.
Projections suggest that we may see no rate increases in 2024, and that the Fed might start dropping its rate later this year, according to the CME FedWatch Tool on March 19. If the Fed rate drops, CD rates will likely follow suit, though it's up to each bank and credit union if and when that occurs.
Purchase process: A bank CD is a deposit product, where you begin earning interest immediately upon deposit. A brokered CD is an investment purchased in a securities account similar to the way a security is purchased. With the brokered CD, you don't start earning interest until settlement date of the trade.
This CD will earn $117.15 on $500 over five years, which means your deposit will grow by 23.4%.
Like other bank accounts, CDs are federally insured at financial institutions that are members of a federal deposit insurance agency. If a member bank or credit union fails, you're guaranteed to receive your money back, up to $250,000, by the full faith and credit of the U.S. government.
What happens if you cancel a CD early?
Many banks don't allow partial withdrawals, so when you break the seal, the whole CD ends. In effect, an early withdrawal means missing out on the rest of a CD's interest that you could've earned. Withdrawing early generally means both paying a penalty and losing remaining interest.
Cons of No-Penalty CDs
That's the price of greater flexibility. Shorter terms. No-penalty CDs typically come in shorter term lengths like 11 or 12 months. So while you're able to lock in a high rate with no risk, you can usually only secure that rate for a year at most.
Institution | Rate (APY) | Minimum Deposit |
---|---|---|
My eBanc | 5.41% | $50,000 |
State Department Federal Credit Union | 5.41% | $100,000 |
State Bank of Texas | 5.40% | $50,000 |
Finworth | 5.38% | $50,000 |
The high CD rates at the end of the 1970s continued into the '80s in a big way. Average rates for 3-month CDs peaked at a staggering 18.65% in December 1980, according to the Fed. They remained in double digits for nearly two years before beginning a slide that saw them bottom out at 5.69% in October 1986.
Term | APY (current | Yield on $50,000 |
---|---|---|
3 months | 5.26% | $682.50 |
6 months | 5.00% | $1,250 |
9 months | 5.55% | $2,081 |
1 year | 4.90% | $2,625 |
References
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