How CD Penalties Work and How to Avoid Paying Them

An exploding piggy bank

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Cashing in a CD before it matures? That could cost you. Banks and credit unions often charge penalties for early CD withdrawals. You might need to pay the penalty if it’s your only option, but it’s worth knowing how these penalties work and how you can avoid them.

CDs are great investments if you want to keep money safe. Funds may be FDIC insured (where applicable), and you can earn more interest than you’ll get from a savings account. But CDs are designed to be longer-term investments. Unlike your checking account, which allows multiple transactions (deposits and/or withdrawals) each day, CDs are meant to be left alone.

Sample Penalty Schedule

If you pull out early, banks typically charge you a penalty that amounts to some of the interest you would have earned if you held the CD to maturity. You might see it quoted as “90 days of interest” for early withdrawal. There is no maximum penalty amount, so make sure you read the fine print. A sample penalty schedule might look like:

  • 11 month CDs or shorter charge three months’ worth of interest
  • 12 to 59 month CDs charge six months’ worth of interest
  • 60 month or longer CDs charge 12 months’ worth of interest

Again, banks set their own policies, which might be more or less forgiving. Check with your bank before you buy a CD – and certainly before you cash out early.

Walking Away with Less

In addition to missing out on money that you would have earned, you can actually lose money and walk away with less than you deposited in a CD.

For example, a 12 month CD is easy to imagine if you cash out after 11 months. You’ll probably walk with more than you initially put into the CD (not as much as it could have been, but at least you earned something). But what if you cash out after 2 months? You haven’t yet earned six months’ worth of interest and you never will – but the bank will still take that amount. To do so, they’ll “invade the principal” or take some of your initial deposit.

How to Avoid CD Penalties

If you absolutely must cash out early, see if there’s a way to dodge any penalties. First, it never hurts to ask. If you’re at a friendly institution or smaller credit union, the staff may waive the penalty for you. If not, all they can say is “no”. You’ll need to do this in-person (or possibly over the phone) if you’re going to ask for a waiver – an automated system most likely won’t do you any favors.

Also, you may qualify for a waiver for death, disability, retirement, and other life events. This is where it’s important (once again) to speak directly with a representative and find out if you can qualify for a waiver.

To avoid penalties in the future (without predicting the future), you can try to use more flexible options. CDs are not bad options – you earn more for promising to leave your money alone – but there might be better alternatives if you keep paying penalties.

  • Liquid CDs are similar to standard CDs, but they allow you to pull money out early. There are sometimes limits on how early and how much, but they’re worth evaluating.
  • Laddering CDs is a strategy where you periodically have a CD mature, giving you the opportunity to take the money penalty-free. For example, you might have a CD mature every three to six months, giving you options.
  • Money market accounts pay more than savings accounts, but generally not as much as CDs. The advantage is that you can do limited spending from the account using a debit card or checkbook.
  • Credit cards are an expensive way to borrow, but if you need money quickly and your CD will mature soon it might cost less to put emergency expenses on a card (and pay it off as soon as the CD matures). Of course, a much better idea is to keep a solid emergency fund.

The Reason Behind CD Penalties

The bank expects you to keep your money invested for a minimum period (like 6 months, a year, or 5 years). In return, the bank is willing to offer you a higher rate. The bank benefits from having some certainty about how long it can use your money, and you don’t have frequent transaction costs with that money.

Why can’t the bank just give you the higher rate and let you use the money whenever you feel like it? Because the bank has also made commitments with the money. The bank lends money to other customers and buys investments that have maturities much like CDs.

If you demand your money early, the bank might have to pay a “penalty” elsewhere. For more details, see how banks make money with your money.