A bank Certificate of Deposit, also known as a CD, is a savings instrument in which you agree to deposit a certain amount of money into a bank account for a specified amount of time. The benefit is a higher interest rate return if you leave the funds until the maturity date. Despite this, many people withdraw the money out of the CD early, without being aware of the potential ramifications of doing so.
There is an argument to be made for withdrawing money from a certificate of deposit early, but overall, it’s generally a bad idea. The reason for this is that you will be required to pay fees, plus you will lose some of the interest you were promised. Interestingly though, in the low interest rate environment that we have found ourselves in over the last several years, the penalties have not necessarily been enough to dissuade many people from taking money out of the bank. Obviously, the larger the deposit into the CD, the higher the penalties.
Although CD rates have been on the rise recently, they still struggle to keep up with inflation. A three-year CD would yield about a 2% APY (annual percentage yield). To put it into perspective, if the CD was $1,000, you would only end up with about $62 in interest if the interest were to be compounded on a daily basis. Should you break the CD before the end of the three-year period, you will be required to pay a fee of a few months’ worth of interest, as well as a bank administration fee.
The fact is, there are risks and penalties for early withdrawal, so it is smart to consider what the pros and cons could be if you break the certificate of deposit.
Some Pros to Breaking the CD
Closing a CD early could make sense if you can find an investment that offers a higher return, as an example. So, if you have a CD that has $100,000 in principal, you may find that you could earn a higher return if you, for example, invested in real estate. In a case like this, the interest of $6,200 that you may need to forfeit, might not be as much to worry about.
Another reason to break a CD is if the penalty is just a few months’ worth of interest. It may be worth your while to lose this small amount in order to access your larger sum of money.Obviously, there are emergencies that arise, like a house down payment or a major medical expense, and in circumstances like this, penalties are often not taken into consideration at all. You certainly don’t want to forgo buying a house or your health over a certificate of deposit!
Some Reasons to Keep the CD intact
There are plenty of reasons to keep a CD intact, not the least of which is if you cannot tolerate volatile investments. Just about any other type of investment is going to be more volatile than a CD, since a certificate of deposit is a guaranteed payment. Also, depending on the terms, you may see the penalty eat into your principal, which can impact you if you were banking on receiving the full sum at the maturity date. Finally, if you are planning on making an unnecessary purchase, a “want” and not a “need”, breaking the CD doesn’t make sense at all.
As mentioned above, breaking your CD, with the currently low interest rates, could make sense if you want to invest in something that offers a higher return. For example, you can even choose a different CD that has a higher interest rate. Beyond that, you could consider bonds that pay a higher coupon.
If you choose to buy property, this longer-term investment will almost certainly give you more back than the CD ever will. In a scenario where you know you are going to come out ahead, there’s no reason not to break the CD.
If you have some type of emergency, it may be necessary to break the CD. In cases like this though, we highly recommend you have an emergency cash fund, or perhaps a money market or savings account available for such situations. Obviously, you never can tell exactly when emergencies might happen, but if you have several months’ worth of savings put away, this should be sufficient to absorb most of the situations.
As stated above, the potential solution to avoid any reason to break a CD is to have additional funds saved so that the CD should be the last place you look for money. Another possible alternative is to break up your CDs into smaller amount. For example, if you are looking to put $8,000 into a CD, you can simply open eight separate $1,000 CDs, making it much easier to break one or two of them if required, thereby also reducing the penalties.
Above all else, make sure that you have a valid reason to pull money out of your CD account. If you are not going to use this money for something vital, rather find the money somewhere else.