CD early withdrawal penalties survey
By Laura Bruce • Bankrate.com

Many people judge a certificate of deposit only by the interest it pays. But research by Bankrate.com shows that paying attention to the early withdrawal penalty on a CD is essential, too.

Penalties vary widely and cashing out prematurely can cost you part or all of the interest earned -- and even part of your principal, the research shows.

Bankrate surveyed 100 institutions  -- the top five banks and the top five thrifts, by deposit size, in the nation's 10 largest metropolitan markets. Data was gathered on each institution's minimum deposit requirement, yield and the early withdrawal penalty for five CD maturities ranging from three months to five years.

Here's what Bankrate found:

CD survey highlights • It pays to shop: Minimum deposits, yields and penalties vary widely within markets for specific terms. • Some penalties not only wipe out interest, they eat into principal, too. • Institutions change terms depending on geography and competition within the market. • Some institutions clearly want to compete for your CD dollars; others don't.

The survey found that penalties vary widely within markets and within certain maturities. Some institutions are far less tolerant of cashing out before maturity and try to discourage the practice with penalties that appear onerous compared to the competition.

Why early withdrawal penalties vary
Why the big differences? Financial institutions vary their CD terms, including penalties, for several reasons. Most commonly, banks use CD deposits to fund their financial needs for things such as loans. An institution that expects higher loan demand at certain times of the year may price CDs accordingly so that a specific maturity looks far better to customers than other CD offerings.

With penalties, banks are also making an assessment of their future cash needs in light of where interest rates may be down the road. If there's too little penalty for early withdrawal, and rates suddenly spike, customers will pull their cash out and buy new CDs at better rates.

"Penalty structure can depend to some extent on the shape of the yield curve," says Bert Ely of Ely & Co., an independent banking consultant. In CD terms, the yield curve is a graphical description of the relationship between rates and the length of the CD. Usually, the longer the term, the higher the rate. "In part, banks may shape their penalties not so much on what the yield curve is today but where they think it's going. Interest rates have squeezed margins and this may make them more sensitive to people cashing out early. They may be thinking that some people will cash out and buy higher rates if the penalty isn't too severe."

If you're hunting for CDs, the penalties have to be considered. Suppose you purchased a five-year CD three years ago when interest rates were very low; is it worthwhile to take the early withdrawal hit and use the proceeds to buy a new CD at today's much-better rates? That will take some analysis on your part, but it's definitely worth the time.

Customers who shop around and are flexible as far as maturity can work that to their advantage even though it may mean buying CDs at banks other than their own. Nevertheless, if there's a stringent penalty attached, be sure you can do without the money for the length of the term.

Penalties that eat into principal
The worst penalties leave you with less money than you had when you invested.