They can cut into your returns.
CDs are generally designed to be long term investments.
You don't just park your money there and withdraw it as needed -- this will cost you if you do.
Banks ask you to invest your money for a minimum amount of time -- anywhere between six months to five years or more).
In return, you receive a higher interest rate than you would with a savings account.
The bank likes knowing how long your money will be invested.
Penalties help insure that you will leave your money where it is.
The money is used by the bank to fund loans and buy other investments.
If everyone was to demand their money at once, they would have a serious financial situation on their hands.
They need commitments to minimize their risk.
CD penalties are typically seen when the money is withdrawn from the CD before it reaches maturity.
Banks usually charge a penalty that is in relation to how much interest you would have earned if you had allowed the CD to reach maturity.
You frequently see banks that charge 90 days of interest for early withdrawals.
However, there is no maximum penalty amount, so it is important to thoroughly know the terms of your CD.
As the term lengthens, the more of a penalty you can expect to pay.
If you have a one-year CD, you may only pay 30 days of interest.
If you have a five-year CD, you could pay 120 days of interest.
Make sure that you know exactly what your penalty will be before you withdraw your money.
It could change your mind.
Banks can and will invade the principal of the CD in order to penalize you.
For example, if you have only had the CD for 60 days, you haven't even accrued 90 days of interest yet.
You will withdraw less than you put in if you are penalized for 90 days of interest.
You have lost money on a fairly risk-free investment.
But if you are truly in a tight spot, you can make a case for yourself.
Go to your bank in person and ask to have the penalty waived.
This often works if:
- You have a good relationship with your bank.
- You have a serious emergency -- like a death in the family.
- You reinvest the amount you don't need to use back into a CD product with the bank.
You were totally unprepared and need money for funeral expenses.
You've held CDs at your local bank for years, without every withdrawing early.
You can always go down to your bank and ask that you are able to break your CD without penalty due to your situation.
Explain that you only need a portion of the CD amount and want to reinvest the remaining money immediately.
It never hurts to ask, and you would be surprised at how many small, local banks would do this for you.
Many CDs and banks actually allow penalties to be waived on CDs that are broken due to death, disability, retirement and other life events.
But if you don't ask, you might not know.
This highlights the importance of talk to your bank in person, instead of conducting the business online or by automated phone system.
In general, you should try to avoid breaking your CDs, except in a true emergency situation.
It cost you money in penalties and loss of potential return.
CDs are low risk, until you start breaking them.