cds

Survey: CD early withdrawal can come at a high price

Beware the auto-renew trap

One place where penalties can be downright dangerous is when it comes to auto renewing CDs.

Most banks will automatically roll over CD balances that have matured after a certain period of time if account holders don't show up to collect their money -- typically 7 or 10 days. That means CD account holders who aren't keeping a close eye on their accounts can see their money locked up again for years -- and inaccessible without paying a penalty.

"It's a good idea for consumers to be cognizant as they approach maturity of the CDs to at least start looking around so you have a plan," Ross says. That way, you can be ready to move your money to capture higher rates, he says.

There can be a lot of variation in how much effort banks put in to notifying consumers. If a bank is offering a particularly subpar rate, don't expect it to fall all over itself to notify CD account holders that their CD is up for renewal, Ross says.

"Banks with these lousy rates -- it's in the bank's best interest to just do whatever minimum amount of work (is required) to notify their deposit holder and then let it roll over," Ross says.

One trick to help you stay on top of your CDs is to time all of them to mature in the same month, so you know to be alert of rollover notifications during that period, Ross says.

Managing early withdrawal penalties

The premium you get for locking up your money for long stretches of time is ridiculously low by historical standards, so in most cases it makes sense to stay out of CDs, particularly longer-term CDs, if you think you might need the money early, McBride says.

"Right now you can earn over 1% in an online savings account, and unlike a CD, where you've locked in your return, those yields will go up as the Fed raises interest rates," McBride says. "We really need to see long-term interest rates pick up before those 3-year, 4-year and 5-year CDs become compelling again."

However, if you are able to find a high-paying, low-penalty CD at a longer maturity, the interest rate premium may be worth risking a penalty in some cases, says Ross -- just be sure the math actually works out.

Why banks charge for early withdrawals

It may seem unfair for banks to charge such a high price for CD account holders to access their own money. But in many ways, it's a necessary evil for maintaining safety and soundness in the banking system.

When you open a CD, it's likely that your money leaves the bank pretty quickly, going out the door for investments and loans to individuals and businesses. Banks don't actually hold much cash on hand relative to the amount of deposits they have on the books -- just a reserve set according to government regulations. Having deposits that are committed for a set period of time can be valuable to them, which is why banks typically pay a higher interest rate on CDs than on liquid savings accounts, Geller says.

"When someone makes a commitment for, let's say, 2 or 3 years, banks are counting on the liquidity being there," Geller says.

When you come back to the bank and withdraw funds from a CD early, you're diminishing the bank's reserves, a shortfall the bank will have to make up elsewhere, Geller says.

That's why Federal Reserve regulations require banks to charge an early withdrawal penalty to discourage that from happening.

So, while early withdrawal penalties may be annoying, you're probably stuck with them.

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