How CD Penalties Work and How to Avoid Paying Them

Penalties are typically 3 to 12 months' interest depending on the term

An exploding piggy bank

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CDs are great investments for those who prefer to keep their money safe. Funds can be FDIC-insured, and you'll earn more interest than you would from a savings account.

But CDs are designed to be longer-term investments. Unlike your checking account—which allows multiple deposits and withdrawals each day—CDs are meant to be left alone. Cashing in or canceling a CD before it matures can cost you.

Banks and credit unions typically charge penalties for early CD withdrawals. You might have no choice but to pay the penalty if a withdrawal is your only option, but in some cases you might be able to avoid the penalty.

The Reason Behind CD Penalties

The bank wants you to keep your money invested for a set period of time, such as six months to a year or even perhaps five years. It's willing to pay you a higher interest rate if you do so. The bank benefits from having certainty about how long it can use your money.

Banks use the money you deposit to lend it to other customers and buy investments that have maturities, much like CDs. If you demand your money early, the bank might have to pay its own form of penalty elsewhere.

A Sample Penalty Schedule

Banks typically charge a penalty that amounts to a portion of the interest you would have earned if you had held the CD to maturity. You might see it quoted as “90 days of interest” for an early withdrawal. There's no maximum penalty amount, so read the fine print.

A sample penalty schedule for early withdrawal might look like this:

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

Banks set their own policies, and some might be more forgiving than others. Check with your bank before you buy a CD—and certainly before you cash out early.

Walking Away With Less Money

When you incur penalties on a CD withdrawal, you can actually lose money and walk away with less than you deposited, in addition to missing out on interest that you would have earned. For example, you’ll probably walk with away more than you initially put into the CD—although not as much as it could have been—if you cash out a 12-month CD after 11 months. But at least you earned something.

On the other hand, if you cash out after two months, you haven’t yet earned six months’ interest and you never will, and the bank will still take that amount. That's called “invading the principal,” which means taking some of your original deposit.

How to Avoid CD Penalties

If you absolutely must cash out early, look for a way to dodge any penalties. First, it never hurts to ask. The staff might waive the penalty for you, particularly if it's an emergency and you’re at a friendly institution or a smaller credit union. Otherwise, all they can do is say no.

You’ll want to make a request for a waiver in person or possibly over the phone. An automated system isn't programmed to do you any favors.

You can usually qualify for a waiver for death, disability, retirement, and other life major events, and in those types of cases, speaking directly with a representative is particularly important. Banks are permitted to offer these waivers, but that doesn't necessarily mean that they will. They're not required to do so by law.

"Liquid" and No-Penalty CDs

Liquid CDs are similar to standard CDs, but they work more like traditional savings accounts in that they allow you to pull money out early. Sometimes liquid CDs have limits as to how early and how much you can withdraw, and you might have to make at least a minimum deposit, but they’re worth investigating.

Your "locked in" period is relatively short with these CDs—less than a week in many cases. Of course, no one would invest in traditional CDs if it were this easy. You'll receive a lower interest rate in exchange for this freedom, somewhere in the neighborhood of 1.25 percent annually (in late 2018), while traditional CDs might pay around 1.7 percent. But that still tends to be more than the average savings account.

Other Options

You can try to use other flexible options to avoid penalties when you're tucking your money away in the future. CDs aren't bad options, but there might be better alternatives if you find that you keep having to pay penalties.

Laddering CDs is a strategy where you'll periodically have one of several CDs mature, often on a six-month or annual basis, giving you the opportunity to take the money penalty-free at that time.

Step-up CDs offer more flexible interest rates. Your rate will increase to keep pace when interest rates rise. This alternative can be attractive if your concern is being stuck with a paltry rate for the whole CD term, but again, these CDs pay less on average than traditional CDs.

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 a money market account using a debit card or a 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.