Many consumers may think of their CD principal as sacrosanct, but should they cash in early, 97 percent of the institutions Bankrate surveyed in February would dig into principal to satisfy a CD early withdrawal penalty if the interest accumulated at that point won't cover it. That's up from 92 percent in our 2010 survey and introduces a risk that many CD investors may not be aware of, says Greg McBride, CFA, senior financial analyst for Bankrate.com.
"The whole reason people invest in CDs is to preserve the value of their principal, but getting your timetable wrong is potentially going to cost them principal," he says.
Fortunately for holders, CD early withdrawal penalties haven't risen on average since our last survey. As in 2010, the most common penalty is still three months' interest for CDs with maturities of less than one year, and six months' interest for CDs with maturities of one year and longer.
Still, penalties varied widely. For closing a one-year CD early, some institutions, including Bank of the West and Boeing Employees Credit Union, charged a penalty of only 30 days' interest.
On the other end of the scale, some institutions, such as Bank of America and JPMorgan Chase & Co., charged as much as $25 in cash plus 3 percent of principal.
Under the above two pricing schemes, if a consumer closes an entire $10,000 one-year CD, it amounts to a difference in penalty of $1.60 versus $325. That difference in penalty underscores the need for consumers to take a close look at the fine print for CDs before committing their money, McBride says.
Why the stiff penalties?
"Banks use CD balances to fund loans, and they don't want consumers taking their money out should interest rates rise. So, they need penalties to be a big enough stick to keep people from leaving en masse and causing them funding problems," McBride says.
One bright spot in our survey: If you accidentally let a CD automatically roll over, the Bankrate survey found banks typically allow a grace period of seven to 10 days for savers to withdraw the money without penalty.
CD early withdrawal penalties undermine appeal
Historically, savers have been willing to put up with CD early withdrawal penalties because CDs generally yield better returns, says Kent Grealish, a partner in Quacera Capital Management LLC in San Bruno, Calif.
"For no-risk money, (investors) can give up a small amount of availability or liquidity in exchange for a modestly higher return over alternatives, which would be savings accounts or (Treasury) bills," he says.
But with CD rates at all-time lows, that dynamic is starting to change, says Dan Geller, executive vice president at Market Rates Insight in San Anselmo, Calif.