CD Rates on Penalty-Free CDs: Six Key Questions

Six Things To Know About Penalty-Free CDs

Perhaps the most valuable adage for consumers pondering financial questions is: "If it seems too good to be true, it probably is." That doesn't mean that every special offer is a scam or even harmful. What it does mean, though, is there is more to the offer than meets the eye. Assume there's a catch--or multiple catches--and make sure you understand the potential downside of any deal before you get into it.

Take penalty-free CDs, for example. If you can lock in CD rates for a period of time but have the option of pulling out anytime you want, isn't that the best of both worlds? Perhaps, but banks can't give you that flexibility for nothing. There are usually trade-offs associated with penalty-free CDs, so there are some things you should know before you sign up.

Here are six key questions to ask about penalty-free CDs:

1. Is the CD rate lower? In exchange for letting you withdraw from the CD early without penalty, the bank may be offering a lower CD rate than on a conventional CD of similar length. You need to know how much the interest rates differ on CDs with or without early withdrawal penalties and whether the flexibility is worth giving up that much interest.
2. What would be the penalty on a conventional CD? One way of answering the above question is to find out how much of a penalty you'd pay on a comparable conventional CD. If the conventional CD rate is higher than the penalty-free rate by more than the value of the penalty, then you'd be better off going the conventional route and paying the penalty if necessary.
3. How does the CD rate compare with a savings account rate? It may be a historical anomaly, but savings account rates are very competitive with CD rates right now. It may be that you can get access to your money and a comparable amount of interest from a savings account.
4. Is the CD callable? No-penalty CDs give you the option of cashing out early, but callable CDs allow the bank to cancel the CD before its maturity date. Make sure the option to end the CD early doesn't cut both ways, especially if you think interest rates could fall.
5. Are there other strings attached? Some penalty-free CDs require that you open a new account with the bank in addition to the CD. You might also be restricted to withdrawing funds from the CD into another account at that bank. Know what other strings are attached and if they are worth the right to close a CD before its time.
6. How much withdrawal notice is needed? Keep in mind that even penalty-free CDs may not allow immediate access to your money. There may be a notice period of a week or so before you can withdraw money. Depending on your reasons for seeking the penalty-free option, this might not meet your potential liquidity needs.

A penalty-free CD can be just the fit for your situation--but only after you've established that the interest rate on the CD is competitive in light of the answers to the six questions.

Source:

High-Yield CDs ? Protect Your Money by Checking the Fine Print • Dec 03, 2008 • US Securities and Exchange Commission: http://www.sec.gov/investor/pubs/certific.htm

Savings & CD Accounts • Bank of America: http://www.bankofamerica.com/deposits/checksave/index.cfm?template=save_overview