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How do I decide which CD account to break into early?

Q: I have about $20,000 split into two CDs. One is a 1-year CD I got about two months ago, and the other is a 5-year CD with about four years left to go. Unfortunately, I need to break into one of them early in order to pay some unexpected expenses. What should I do?

A: It's impossible to say for sure without more specifics, but by walking through a cash flow projection, you should be able to set up a comparison for your CD accounts that will help you make this decision.

Review your CD penalty terms carefully

In most cases, you will find the early-withdrawal penalty on a long term CD larger that on a shorter-term CD. This is not always the case though, so, you need to start by taking a look at your CD terms to make sure you fully understand all the conditions surrounding the early-withdrawal penalty.

Some such penalties are stated as a percentage of the CD deposit, while others are described as a certain period's worth as interest. That is, one CD may list its penalty as equal to 0.25 percent of the deposit, while another may list its penalty as six months' worth of interest on the CD.

Note that some CD penalties decline or even disappear over time. Thus, if you've held the CD for a while, it is possible that the penalty might be less than you think it is. That probably is not the case with your CDs because you have held each for a relatively short portion of its term. But it is worth checking to see if there has been any reduction in penalty, or if you are approaching a date when such a reduction would become effective.

Once you know for certain what the applicable penalty is for each CD, calculate it in dollar terms. This is the first part of the comparison you need to make.

Weigh the penalty against lost interest

The second part of that comparison is to figure out how much interest you would lose by breaking each CD. You can only really project this for the remainder of the 1-year CDs term since you don't know what rate you would be able to renew it for when it matures. In any case, calculate the interest you would lose for that period for each CD in dollar terms.

Now add the penalty in each case to the potential lost interest from each CD and compare the two. This will give you a fair idea of the near-term dollar impact of breaking each CD, and this comparison should help you make your decision.

Your question is a reminder that early-withdrawal penalties are something to look at when shopping for CDs. Naturally, people focus most on finding the best CD rates, but when it comes down to a choice between CDs with reasonably competitive rates, finding one with a milder early-withdrawal penalty might be the decisive factor.

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