How CD Early Withdrawal Penalties Work

A Certificate of Deposit, or CD, is a savings and investment vehicle that provides you with a predictable interest rate and a set maturation date (When you can withdraw the funds). As a result, it creates an appealing way to add stability and diversity to your investment portfolio, while allowing you to save money for a specific event, whether that be a trip in the near future or retirement years down the road. However, one downside of CDs are early withdrawal penalties (Taking money out of your CD before the maturation date). Since these penalties can be costly, it is wise to understand how they work, and what strategies you can use to avoid them.

Introduction to Certificates of Deposit

Certificates of Deposit (CDs) are a type of investment vehicle offered by banks that allow you to grow your initial investment by earning interest on your deposit over a set period of time. Thanks to the fact that they are FDIC insured for up to $250,000 and grow at a predictable and locked interest rate, they provide a safe way to grow your money.

When you open a CD, you agree to leave your money there for a specific period of time, whether that be 3 months or 3 years. The longer you agree to keep your money in the CD, the higher the interest rate you usually receive. However, do not be tempted to lock up money you may need sooner than the term of your CD just to earn a higher interest rate. Withdrawing your money early will trigger certain penalties that can often cost you all of the interest earned on your deposit.

Significance of CD Early Withdrawals

There is a good reason that banks charge CD early withdrawal penalties for removing your money before the term of your CD is up. Doing so hurts both the bank and your own finances.

Impact on Bank

By placing your money in a CD, you allow the bank to use that money for the duration of the CD. Your bank may use that money to make loans to other customers, create other investments, and so forth.

When you take your money out of a CD early, you disrupt the financial plans and cash flow of your financial institution. Early withdrawal penalties help deter you from taking your money out before the CD matures, and helps to compensate the bank for any inconvenience your early withdrawal creates.

Impact on Personal Finances

In addition, and perhaps more importantly, taking your money out of your Certificate of Deposit early can significantly set back your own financial goals. Early withdrawals mean that you do not earn the interest you had planned on, and can make meeting your financial goals much harder.

Early withdrawal penalties for a CD can help discourage you from making this somewhat drastic move by further reducing the amount of money you receive from your investment. In some cases, the penalty can be equal to the amount of interest earned already, leaving you with no gain from your CD.

Due to these impacts, early withdrawals should be made only after careful consideration and in order to pay for unforeseen and unavoidable expenses.

How Penalties Are Calculated

There is no single fee that you face for removing your money from a CD early. Instead, your penalties will depend on a number of factors, including the following:

Your Financial Institution

Early withdrawal fees are set by the banks. You may want to compare penalties before you choose an institution to use for your CDs.

Your CD Term

The longer the term of your CD, the higher the penalties are likely to be.

The Withdrawal Amount

Sometimes, you can make a partial early withdrawal on your Certificate of Deposit. In these cases, your fee may be calculated based on the amount of money you take out. The more you withdraw, the higher the fee you pay to do so.

Penalty Amounts

The federal government sets minimum penalties for CDs, but there is no maximum penalty. That number is determined by the individual bank, and other factors, such as those listed above.

Usually, your withdrawal penalty will translate into a certain number of days or months of interest. For example, if you take your funds out within 6 days of your deposit, you will usually owe a penalty of 7 days’ interest. If you withdraw later than 6 days after deposit, you could owe anywhere from 90-365 days’ worth of interest.

How to Avoid Withdrawal Fees

If you want to avoid early withdrawal penalties for CDs, there are a few strategies you can employ. Note, however, that most of these strategies take place before you commit to a particular Certificate of Deposit, so do your research and planning before investing your money in this vehicle.

Choose the right bank

Make sure you understand the penalties you face for the CD you want, and choose a financial institution that offers lower fees. You may also want to find a bank that offers more flexible withdrawal terms. You may earn a lower interest rate as a result, but the flexibility could be useful if you anticipate needing your money from your CD before the maturation date.

Align your CD with your financial goals

Before getting a Certificate of Deposit, make sure you understand your financial goals, your cash flow, and your preferred timeline. Do you have a vacation coming up in 6 months? Consider a CD of 3 or 6 months so you have access to cash for your trip at the right time. Do you anticipate an urgent home repair in the next two years? Limit your CD to a maturation date of no more than 24 months. By doing so, you can ensure that your money is available when you need it, penalty-free.

Build a CD ladder

Building a CD ladder refers to the process of purchasing multiple CDs at differing maturation dates. By doing so, you can place some of your money in longer-term CDs that earn higher interest rates while also ensuring that you have some money available in short-term CDs in case you need your money to be liquid in the near future. Doing so can help you to both improve the liquidity of your funds and enjoy higher interest rates.

Request a waiver

In some cases, you can request a waiver of your CD early withdrawal fees. Usually, these waivers are available in specific, limited circumstances, including death, disability, and proven incompetence.

Understanding early withdrawal fees for Certificates of Deposit is essential before you purchase a CD. By understanding these fees, and by taking strategic steps to prevent them, you can get the most benefit possible out of your investment. And, you can grow your money even in the face of unexpected expenses. If you want a CD, consider Bank of South Texas for reasonable rates and a friendly, professional staff here to support your financial goals.