Penalty For Early Withdaw of CDs
A CD, or certificate of deposit, is considered a deposit account. Most CDs have time frames of anywhere from three or six months through five years or longer. These time frames are known as the certificate of deposit maturity.
When a certificate of deposit reaches its maturity, you have a grace period during which you can withdraw your funds or roll them into a new CD. However, if you withdraw your funds before the maturity – regardless of whether it is a short or long term CD – then you are likely to face a CD penalty from your bank or credit union.
Why CD Issuers Have Penalties for Early Withdraw
Because banks make their money by loaning out their deposited funds to borrowers, they need to have a certain amount on hand in order to do so. Banks loan out money that people deposit in the form of CDs because the CD account holders have committed the funds to the bank for a specific period of time. Therefore, early withdrawal penalties will help the bank to deter depositors from withdrawing their funds prematurely.
Most banks have two levels of penalties on CDs. For short term CDs with maturities up to six months, banks will often charge a penalty that is equal to three months’ of the certificate of deposit interest. For withdrawals from longer term certificates of deposit, you will typically be charged an amount somewhere between three and six months of interest.
Some banks will not charge you a penalty based on the certificate of deposit interest but rather they will charge you a penalty equal to one percent of your initial CD investment amount. And, when short term certificate of deposit interest rates go below one percent, then early withdrawal penalties could be in the form of a reduction of principal.
How You Can Avoid Penalties on Your CDs
Often when investors have a maturing CD, they will immediately reinvest the principal into a new certificate of deposit that offers the highest CD rate. However, sometimes you may want to forgo a high CD rate of return in lieu of avoiding an early withdrawal penalty.
This may be done by staggering your CD maturities, a strategy called CD laddering. For example, you could divide your total amount of investable funds and invest in several CDs with varying lengths of maturity. By doing this you will incur fewer early withdrawal penalties because you will not have to wait very long for your next certificate of deposit to mature and have access to your invested funds. And, if you do have to withdraw your funds early from one of the CDs, the smaller invested amount will reduce the size of your penalty.
Carefully read the CD disclosure statement to make sure that you understand all of the terms and conditions of that CD.
- Best CD Rates – find the best CD interest rates for your investment
- CD laddering: how to structure the maturities of certificates of deposit to increase CD yield and ensure that you have access to funds when you need them.
- CD Rate Calculator: how to calculate the interest return on CDs.
- CD Interest Rates: important facts to know about CD interest rates.
- CD Investor Facts: overview of key facts that any investor needs to understand before making a CD investment.