For many banking customers, a certificate of deposit (CD) is a product that is listed on banks’ websites or mentioned in brochures but is never seriously considered. What’s interesting is that, years ago, CDs were all the rage, but as deposit interest rates fell, interest in these unique accounts fell, as well.
But interest rates are not the only deterrent for many consumers. Some who realize that CD interest rates are better than those of savings accounts still shy away from this option due to the account’s lack of liquidity.
It’s well-known that depositing money into a CD means not touching it for anywhere from 30 days to five years. If funds are withdrawn, financial establishments usually make it clear that a penalty will be imposed. While this can appear to be a hard rule, there are ways to get out of a CD without paying an early withdrawal penalty.
Why CD Penalties Haven’t Budged in Decades
CD penalties, unlike other aspects of deposit accounts, have remained relatively consistent for decades. What’s interesting about these penalties, however, is that they had room to change drastically nearly 30 years ago.
On April 1, 1986, final deregulation of bank deposits took place via the Depository Institutions Deregulation and Mandatory Control Act. This act removed a mandate for banks to enforce a minimum early withdrawal penalty of three months’ interest if principal funds were withdrawn from a CD account prior to maturity.
Following this date, banks were no longer required to issue penalties at all. While a small handful of establishments reduced or eliminated their penalties, most maintained the original minimum or increased it.
This change — or lack thereof — in penalties is a far cry from the changes that have occurred with CD rates. While penalties have remained roughly the same for decades, rates have plummeted over the same period.
According to Forecast Chart, a short-term, six-month CD averaged 15.77% APY in 1981 — a figure that is unheard of now. The average six-month CD rate as of May 2014 was 0.22% APY, according to GOBankingRates’ database, powered by Informa Research Services. Six-month CDs in 1981 paid a whopping 70 times what they’re paying depositors today.
Of course, we know that economic factors have played a major role in why banks and credit unions have dropped their CD rates. Following the financial crisis of 2008, which resulted in bank failures by the hundreds, the Federal Reserve reduced savings rates to the near-zero mark and banks followed suit.
As for why banks haven’t adjusted CD penalties, some speculate that they are simply happy with them. Unfortunately, these penalties make CDs unattractive options for consumers who want to invest but are afraid to lose the little interest they’ve earned if they need to retrieve funds prematurely.
Can You Avoid the Early Withdrawal Penalty?
Most financial institutions make it clear that they plan to penalize you for pulling your principal dollars out of the account prior to maturity. In agreeing to a certificate of deposit, you are telling the establishment that it can use your funds without interruption for a specified period of time.
So if you choose to withdraw early, you are likely to face the standard penalty of three -months’ interest for maturities of less than one year and six-months’ interest for maturities of one year or longer.
Banks can easily argue that they offer other types of accounts that give you greater access to your money, including checking and savings accounts. So if you want to earn the higher interest offered with CDs, you have to surrender access to your funds.
With that said, getting out of a CD without paying any penalties is pretty tough, so the best way to avoid a penalty is opening an account for which the financial institution explicitly states no penalty will be enforced. The good news is that there are a few establishments out there that do just that.
Where to Find No-Penalty CDs
A handful of financial institutions offer no-penalty CDs, also known as liquid CDs or risk-free CDs. Here is a short list of establishments currently offering them:
- Ally: Ally offers an 11-month No Penalty Certificate of Deposit that comes with a fixed rate. The account allows depositors to withdraw the full balance and interest any time after the first six days of funding the CD, whereas standard CDs come with a penalty of 60 days’ interest.
- Bank of America: Bank of America offers a nine-month Risk-Free CD that requires a $5,000 minimum opening deposit. The early withdrawal penalty is waived after six days of the account term or the first six days following any partial withdrawal.
- PNC Bank: PNC Bank offers customers the Ready Access CD with terms of three months or 12 months and a minimum deposit requirement of $1,000. No early withdrawal penalty is enforced after the first seven days. Partial withdrawals are not permitted.
A few other establishments offering no-penalty CDs include Salem Five (nine-month CD that requires a minimum opening deposit of $10,000), WFSF Bank (three- to five-month accounts available with available withdrawals after seven days) and Susquehanna Bank (12-month CD with $5,000 minimum required deposit).
Another option for consumers to consider is brokerage CDs. They are unique accounts in that they are offered by brokerage firms or agencies, instead of banks and credit unions.
These CDs come with no early withdrawal fees, which is great. But before opening one, it’s good to note that they often are not placed in your name because brokers like to co-mingle deposit accounts representing the funds of multiple customers.
Also, according to the Federal Deposit Insurance Corporation (FDIC), your CD might not be FDIC-insured since it is purchased through a broker. If it isn’t, you have to rely on that broker’s promise to place the funds into a CD account at an FDIC-insured bank.
Finally, consider that brokered CDs are sold on a secondary market, which means you could actually receive less than you paid for it in return, unlike traditional bank CDs.
Do No-Penalty CDs Come With a Catch?
The perks of no-penalty CDs might be winning you over, but before jumping aboard, note that a number of catches might come with these accounts:
- Second bank account requirement: Often, no-penalty accounts require a second account with the bank that funds can be moved to in case of early CD withdrawals.
- Larger deposit requirement: Some establishments also require customers to deposit more than the typical minimum when opening a no-penalty CD. In some cases, the required deposits could reach into the tens of thousands.
- Term requirement: No-penalty CDs might also eliminate the ability to choose a specific term. In most cases, liquid CDs come with a shorter term than average CDs.
- Lower rates: You might be offered lower CD rates for liquid accounts since you are granted the option of withdrawing funds at any time.
There’s no doubt that no-penalty CDs can be beneficial to individuals who want to gain access to funds without worrying about a steep fee. It’s certainly better than trying to convince the bank that you deserve to avoid a penalty for early withdrawal (however, this could be possible if you have a good track record with your establishment).
Unfortunately, individuals who already have money in a CD might face a tough, uphill battle when it comes to withdrawing funds while avoiding penalties. But if you are just getting ready to open your first CD account, it’s good to know that there are a number of no-penalty options available to you.
Photo credit: David Castillo Dominici