Lock around money © Lev Kropotov/Shutterstock.com

If you take money out of a certificate of deposit before it matures, be prepared to pay a price, perhaps a hefty one.

Bankrate’s 2015 CD Early Withdrawal Penalty Survey found that banks charge big penalties that not only cut into interest earned, but also may substantially eat away at your principal. And on longer-term CDs, those penalties have increased.

Long-term CD penalties get tougher

Here are the most common penalties Bankrate found for 5 popular maturities:

  • 3-month CD: 3 months’ interest.
  • 6-month CD: 3 months’ interest.
  • 1-year CD: 6 months’ interest.
  • 2-year CD: 6 months’ interest.
  • 5-year CD: 12 months’ interest.

The only maturity that has seen significant change in the past year is the 5-year CD. This year, 12 months’ interest is the most common penalty. Among the banks, thrifts and credit unions Bankrate surveyed in 2014, institutions were just as likely to charge 6 months’ interest as 12 months’ interest.

If these typical penalties seem high, rest assured they can get worse. Some institutions in the survey, conducted Oct. 1-13, 2015, charge penalties as high as 2% of the total principal on 3- and 6-month CDs, far exceeding the amount of interest they pay out over those terms. On some 1-year CDs, the penalty is as high as 2.5% of total principal, or 4% of the amount withdrawn, again far exceeding the likely payout.

Short-term CDs carry big penalties

Institution Market Yield Penalty Penalty on $10,000
Institution: Fifth Third Bank Market: Detroit Yield: 6-month CD: 0.05% Penalty: 2% of principal withdrawn Penalty on $10,000: $200
Institution: Salem Five Market: Boston Yield: 12-month CD: 0.25% Penalty: 4% of amount withdrawn Penalty on $10,000: $400

Source: Bankrate.com

So why are penalties climbing on longer-term CDs? Basically, banks don’t want to pay account holders long-term deposit rates for what end up being short-term deposits, says Dan Geller, a behavioral finance scientist at Analyticom, a financial industry consulting firm.

“If someone locks their money for 5 years, they get a higher rate from the bank than a 3-year or 2-year term, so the early withdrawal penalty is proportional to the level of interest rates that the bank is paying,” Geller says.

Potential interest rate hikes by the Federal Reserve may also be a factor; banks don’t want all their CD account holders heading for the exits in search of higher rates when the Fed finally does act.

CD early withdrawal penalties vary

Penalties on 2-year CDs Yield (using national average yield) Penalty on $10,000, if withdrawn after 1 year
Penalties on 2-year CDs: 3 months’ interest Yield (using national average yield): 0.44% Penalty on $10,000, if withdrawn after 1 year: $11
Penalties on 2-year CDs: 6 months’ interest Yield (using national average yield): 0.44% Penalty on $10,000, if withdrawn after 1 year: $22.02
Penalties on 2-year CDs: 9 months’ interest Yield (using national average yield): 0.44% Penalty on $10,000, if withdrawn after 1 year: $33.05
Penalties on 2-year CDs: 12 months’ interest Yield (using national average yield): 0.44% Penalty on $10,000, if withdrawn after 1 year: $44.09
Penalties on 2-year CDs: $25, plus 3% of amount withdrawn Yield (using national average yield): 0.44% Penalty on $10,000, if withdrawn after 1 year: $325
Penalties on 2-year CDs: 2% of amount withdrawn, but not more than total interest earned Yield (using national average yield): 0.44% Penalty on $10,000, if withdrawn after 1 year: $44.09

Source: Bankrate.com

Penalties can target your principal

With CDs, penalties are often expressed as “X months’ worth” of interest. For instance, say you put $1,000 in a 5-year CD paying 2% a year, with a penalty of 12 months’ interest. If your car’s transmission dies that same week and you need that $1,000 back to fix it, you’re going to pay a penalty of about $20, or what you’d earn on the CD over the course of a year.

But depending on the terms of the CD, you could get back either $980, the full $1,000 or somewhere in between. For instance, many CDs allow the bank to deduct the penalty from your principal if the interest you’ve earned won’t cover it — a major concern when you’re talking about an investment where the biggest upside is that it’s guaranteed not to lose value.

“People invest in CDs because they want to preserve their investment,” says Greg McBride, CFA, chief financial analyst for Bankrate.com. “But you have to recognize that in the overwhelming majority of cases, the early withdrawal penalty can jeopardize the ability to keep your initial investment intact.”

Overall, 89% of the financial institutions Bankrate surveyed have policies that allow them to dig into principal to satisfy a penalty.

Watch where the penalty is assessed

Another factor in how much pain a penalty causes is whether it’s assessed on the entire principal or just on the amount withdrawn. For those taking out small amounts, the former may lead to huge, out-of-proportion penalties. In the survey, banks were evenly split on whether they wanted a piece of just the amount withdrawn, or the total principal.

For instance, say you had a 5-year $10,000 CD paying 2% interest that wasn’t scheduled to mature for a month, but you needed to take out $1,000 to cover the aforementioned car repair. If your bank assesses a penalty of 6 months’ interest on the total principal, you’d end up paying a $100 penalty to take out $1,000 — pretty steep.

One way to get around this is to separate your CD deposits into smaller chunks, says Dylan Ross, CFP professional, director of communications and financial planning at the Garrett Planning Network in Burlington, New Jersey.

“If you’re getting the same rate on one $10,000 CD or 10 $1,000 CDs, and you’re dealing with a potential penalty, by breaking it up … if you do need a partial withdrawal, you don’t have to break one giant CD, you break however many smaller CDs,” Ross says.

Of course, for this strategy, you’ll need to deal with a bank where the minimum deposits are fairly small, he says.

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.