Q: Now that interest rates are rising, how do I know when it's worth paying the penalty to cash in a CD early so I can start a new one at higher rates?
A: It's probably too early to make that kind of move now, but the possibility of rising CD rates is strong enough that it is certainly worth thinking about when it might be time to pull the trigger.
The simple answer is that it is worthwhile when the penalty you would pay is worth less than the extra interest you would earn by switching to a CD at more current rates. However, behind that simple comparison are several dimensions:
- How big a penalty do you face? The starting point is to look at your current CD term to see how big a penalty you are in for. Keep in mind that some penalties decline later in the CD's term, so make sure you find out the penalty applicable to the amount of time your CD has left.
- How far have rates come? Thus far, while some types of interest rates have started to rise, CD rates have yet to move. Keep an eye on the market so you'll know when the rise in rates starts to influence the CD market.
- How long do you have to go on your CD? If you face a penalty of 10 basis points, you don't necessarily need that big a rise in rates to make it worth switching. For example, if rates rise by 5 basis points and you have four years left on your CD, you would gain a total of 20 basis points by switching, or twice as much as the penalty you face.
- How far do you think rates will go -- and how fast? If you think rates will continue to rise swiftly, you may want to wait even once you could benefit by switching.
- How far are the best CD rates ahead of average rates? As a practical matter, you shouldn't be concerned with the average change in CD rates. You'll want to shop for the best CD rates, and make your decision based on how much you could gain by switching from your current CD to one of today's best CD rates.
If you get the opportunity to benefit from making this kind of move, take a lesson from this situation and make the early-withdrawal penalty one of the terms you look at when choosing a new CD. After all, just as interest rates fell for a long time, they may now experience an extended rise. This may not be the last time you'll want to break into a CD early to switch to more up-to-date rates.
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