What is a CD early withdrawal penalty? #CashNews.co

If you’re a dedicated saver looking for a higher interest rate than traditional savings accounts offer, a certificate of deposit (CD) may be a worthwhile alternative for your cash. Banks, credit unions, and online lenders offer CDs, which are special deposit accounts that typically pay you a generous fixed rate for investing your money for a set term — usually a few months to a few years.

While CD rates are generally higher than those of traditional savings accounts, CDs often come with early withdrawal penalties you won’t see with savings accounts. These penalties can easily burn through any interest you may have earned. Here’s what to know about CD early withdrawal penalties if you’re considering a new CD.

What is a CD early withdrawal penalty?

A CD early withdrawal penalty is a fee a bank or credit union charges if you withdraw your money from a CD before it matures, or its term ends. These penalties often amount to a percentage of interest on the account.

Deposits are an important source of funding and liquidity for banks and credit unions. And when you deposit money into a CD, you’re essentially “promising” you’ll keep that money invested for the term the bank has set. Withdrawing your money early can impact the bank or credit union’s bottom line. Thus, they may attempt to recoup their costs by charging you an early withdrawal penalty.

Early withdrawal penalties can vary depending on the institution and the terms of your CD. So you might see an early withdrawal penalty of 90 days’ interest with one bank and six months’ interest with another. Reviewing account terms and conditions can offer insight into potential penalties before you open a new CD.

How to calculate a CD early withdrawal penalty

Penalties vary by institution, and you’re often charged different penalties depending on your CD term. You’ll usually incur higher penalties with longer-term CDs.

Let’s say you deposit $20,000 into a one-year CD with a 3.00% rate. The terms of the CD state your early withdrawal penalty will amount to three months of simple interest. There’s a financial emergency, and you need to withdraw your balance after six months.

Here’s how your bank or credit union will likely determine the total fee:

The generic formulas to use for calculations are as follows:

• Assuming the penalty is months’ worth of interest:
  (Rate / months in a year) x length of penalty in months x amount withdrawn = penalty

• Assuming the penalty is days’ worth of interest:
  (Rate / days in a year) x length of penalty in days x amount withdrawn = penalty

Factors to consider before withdrawing from a CD early

As mentioned, it’s essential to review account terms and conditions before opening a new CD. Doing so will help you understand how penalties for early withdrawals work, along with other key account information.

Potential consequences for withdrawing money from a CD before it matures include lost interest and potential fees. And those fees could even eat into your principal balance if the interest you’ve earned on your deposit is less than the penalty amount.

Alternatives to withdrawing from a CD early

If an unexpected cost comes up and you need money fast, drawing from your checking or savings account is generally better than taking money out of a CD. For this reason, it’s smart to build up your emergency savings before you deposit funds into a CD. That way, you’ll have access to cash if you need to pay for an auto repair, vet bill, or unanticipated medical expense.

Alternatively, a no-penalty CD may be worth considering if you’d like a more generous savings rate and a traditional CD isn’t the best option. These CDs provide more flexibility with withdrawals than traditional CDs, and you typically won’t incur a penalty if you take money out early. That said, no-penalty CDs may have lower rates than traditional CDs, and partial withdrawals may not be permitted.