Long-term financial solutions require careful consideration. If you’re in the market for a low-risk and stable option, the Certificate of Deposit (CD) is widely accepted as one of the most popular options. However, when it comes time to managing your finances, it’s important to find solutions that best serve your current situation. In some cases, breaking a CD early is the best course of action. But before making a decision, it’s essential to know all of the possible benefits, drawbacks and details about breaking a CD early for a better rate.
What is a Certificate of Deposit (CD)?
A Certificate of Deposit, commonly referred to as a CD, is a low-risk, time-based financial product issued by banks and credit unions. A CD is an IOU from a bank to its depositor, a promise to repay the depositor’s principal and interest after a specific period of time. A depositor is required to keep their funds in the CD for the specific amount of time that was agreed upon when opening the account – usually between 6 months and 5 years. It’s important to remember that you can’t withdraw money from the CD until the date it matures.
What’s the Difference Between Breaking and Cashing Out a CD Early?
When it comes to breaking a CD, there’s a distinct difference to consider when compared to cashing out or liquidating a CD. Breaking a CD is where the banks impose a penalty for withdrawing money from a CD before the maturity date, taking away a portion of the interest that has accrued. Cashing out a CD, on the other hand, means giving the bank the full amount of money contained in the CD’s interest and principal, minus any penalty fees.
What Are the Benefits of Breaking a CD Early?
Breaking a CD early isn’t typically recommended, as penalty fees can take away from your total returns. However, in certain circumstances, breaking a CD early for a better rate can be beneficial. Here are a few of the benefits of breaking a CD early:
- Access to Funds
In some cases, breaking a CD early might be the only way to obtain the funds you need while still salvaging the remaining interest you could have earned on your investment.
- Increased Interest Rates
Some CD’s may have low interest rates compared with more current ones. By breaking your CD early, and reinvesting the funds in a new CD with a better rate and/or less penalty, you’ll not only gain access to your funds, but you may also be able to increase earning potential of the CD by investing in a CD with a better interest rate.
- Lower Opportunity Cost
Inflation causes prices and the cost of living to rise steadily over time. When you break a CD early, you’re not required to leave your money in that CD at an increasingly lower rate of return. By breaking your CD, you’ll be able to reinvest your money in an account with a better rate of return, and make your money work harder for you.
What are the Risks of Breaking a CD Early?
Breaking a CD can be beneficial, but it’s important to understand that there are also certain risks associated with breaking a CD early. Here are a few possible risks to consider before you decide to break a CD early:
- Penalties
When you break a CD early, you are typically required to pay a penalty. In fact, banks can charge a penalty of anywhere from 3 to 6 months’ worth of interest, according to the FDIC. It’s important to factor these penalties into your decision before breaking a CD early.
- Lower Interest Rate
In some cases, the bank account with the higher interest rate that you’re planning to break your CD for will yield a lower overall return than your existing one, despite a higher interest rate. This can be due to the high penalties associated with breaking a CD early.
- You Could Lose the Interest on Your Investment
In some cases, the interest you’ve already accrued on your CD will not be returned to you when you break the CD early. This means that the money you could have earned could be lost, despite breaking a CD early to secure a higher interest rate.
How Do You Break a CD Early?
Breaking a CD early may be a viable option depending on your current situation. However, you should always consider the risks before making the decision to break a CD early. But if you’ve decided that breaking a CD early is the right decision for your financial goals, here’s what you’ll need to do:
- Contact the Bank
The first step is to contact the bank you opened the CD with. Depending on the bank, you may be able to do this online, over the phone, or in person.
- Calculate Potential Penalties
Before breaking a CD early, you should fully understand the penalties you could be required to pay. Speak with your bank or credit union to determine how much you’ll be penalized.
- Request a Form
Once you understand how much you’ll be penalized, you can request a form to break your CD early. In some cases, this form or request can be done online.
- Sign the Form
Once you receive the form, you’ll need to sign it and include the details of your CD and the date as well as amount of the fee.
- Submit Your form
After signing the form, you’ll need to submit it to the bank or credit union before the end of the calendar year in which you’re breaking the CD.
When you’re in need of access to quick funds, the certificate of deposit may not be the ideal option. Breaking a CD early may provide you with access to these funds, but it’s important to factor in the fee penalty. Consider all of the associated costs and benefits before making a decision. In some cases, breaking a CD early may prove to be beneficial; in others, it may be more cost-effective to leave the CD to maturity. Take the time to review all of your options before making a decision, and speak with your bank or financial advisor if you need more help or guidance.
