What is a CD early withdrawal penalty?

A certificate of deposit (CD) can offer a sweet spot between investing (which can be riskier) and typical savings vehicles (which might not offer as high a return on your money). Locking in higher interest rates with a CD might feel like an easy financial win—until life throws a curveball and you need that cash early. If you withdraw your funds before the CD term ends, you might be charged a CD early withdrawal penalty. And these penalties can significantly reduce the interest earned.

To help you avoid losing out on interest earnings, let’s look at how financial institutions calculate early withdrawal penalties for CDs—and how you can avoid (or at least minimize) their impact.

What is a CD account?

First, how does a certificate of deposit work? A CD is a type of savings product that pays account holders a guaranteed amount of interest, assuming funds remain in the account until the CD term is over. Most banks and credit unions offer a range of CD terms. This flexibility makes it easy to find a CD that works for your savings situation.

For example, if you want to buy a home in 12 months, you might put the money you’ve saved for a down payment in a CD with a 9-month term. CDs are insured by the FDIC—standard FDIC insurance amount is $250,000 per depositor, per insured bank, and per account ownership category (e.g., CD, checking, or savings accounts).

The interest rates on CDs are typically higher than traditional savings accounts and, unlike savings accounts, they will not change from the time you invest in them. There is, however, a tradeoff to these predictable and potentially higher rates. While you can access your savings account whenever you want, the money in a CD is essentially off-limits for the term length. You typically can’t withdraw funds from a CD without paying a penalty fee. Many consumers find the benefits of a CD outweigh this temporary lack of access. In fact, some CD users see restricted access as a pro, as it reduces spending temptation and can keep savings goals on track.  

 How a CD early withdrawal penalty works

A CD early withdrawal penalty helps encourage savers to keep their money in the CD, making it possible for financial institutions to use those funds for things like loans (which is why they can guarantee the interest rate). Because CD term lengths vary so broadly, knowing what’s best for you can be challenging.

To better understand how a CD early withdrawal penalty works, let’s address some frequently asked questions:

• Do I pay a penalty for withdrawing from a CD early? Unfortunately, you typically will need to pay a fee to withdraw your funds or accumulated interest early.
• Can you withdraw interest from CDs without penalty? Some banks offer the option of withdrawing earned interest, usually on a monthly basis. The penalty is enforced when an investor withdraws funds prior to maturity. And while you may find “no-penalty CDs” that won’t charge you this fee, there’s a tradeoff: They typically offer lower interest rates than other CDs of similar term lengths.
• What is the penalty for early withdrawal of a CD? You should confirm the exact fee amount with your bank or credit union. Financial institutions set their own CD fee structure, so the penalty rate can vary, but a minimum penalty amount is established by federal law, per the Federal Reserve. For instance, savers who withdraw any funds from the CD within the first six days after they make a deposit pay at least seven days of simple interest. Fees are typically higher for longer-term lengths.

Tip: Simple interest is calculated by multiplying the daily interest rate by your principal—in this case, the amount of the CD—and by the number of days that elapse between payments.

How banks calculate their penalties varies. Some might base the fee on the amount you withdraw, while others base it on the principal balance of the CD.

Ways to avoid a CD early withdrawal penalty

A little planning goes a long way when it comes to avoiding penalties on CD early withdrawals.

Here are three tips that can help maximize CD earnings, even if you need to access some of the funds before they mature:

• When investing in CDs, use funds that you likely won’t need in the short term. A high-yield savings account is typically a more flexible option for an emergency fund or cash you want to have available.  
• Look for CDs that allow you to withdraw earned interest (but not principal) without a penalty.
• Consider a CD ladder. Opening multiple CDs with varying term lengths gives you more access to your money than a single long-term CD. And if interest rates rise, a CD ladder strategy helps you take advantage of higher rates the next time a CD in your ladder renews. 

The promise of guaranteed earnings is a big appeal for those looking to open a CD. But you must understand the potential impact of a CD early withdrawal penalty—so you can save without surprises.

Articles may contain information from third parties. The inclusion of such information does not imply an affiliation with the bank or bank sponsorship, endorsement, or verification regarding the third party or information.

The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover, a division of Capital One, N.A., or its affiliates.