With interest rates so low these days, you may not want to lock up your money in a certificate of deposit. However, if interest rates continue to fall or stay low, CDs can be a better investment than savings accounts for some of your money. Most CDs are pretty straightforward, but there are some important details that are often overlooked. That could be costly. I've put together a list of 10 CD tips and potential gotchas. If you're a regular reader of this blog, you probably have seen me mention some of these in several past blog posts. I decided it would be a good idea to consolidate them into one list for those new to CDs.
- Most banks and credit unions set up CDs so that they automatically renew when they mature. The new CD will typically have the same term as the matured CD. However, the interest rate may be much lower especially if the original CD was a special. Always check the interest rate of a renewed CD to ensure it's still competitive.
- When a CD matures and renews into a new CD, there is typically a grace period between 5 and 15 days when you can close the CD without an early withdrawal penalty. If you close the CD after this window of time, you will be hit with an early withdrawal penalty. The bank will usually send a notice a few weeks before the CD matures. It's best to mark the maturity date on your calendar when you first open the CD.
- If you close a CD during the grace period rather than renew it, you may not receive interest during the grace period. If you're going to close a CD, it's best to close it on the day of maturity or soon after to avoid loss of interest.
- When the CD matures and renews into a new CD, be aware of other potential changes in addition to the interest rate. A new CD disclosure may take effect. For example, if you have a 5-year CD at Pentagon Federal Credit Union that is going to renew in November 2011, the early withdrawal penalty for the renewed CD will be double of what it used to be (new 5-year CDs now have a penalty of up to 12 months of interest).
- Many banks don't take instructions to close a CD before maturity. You have to wait until it matures. Even if the bank will accept instructions, be very careful in specifying the closure date. There was a case in which Discover Bank closed a reader's CD early when she intended for the CD to be closed at maturity (see post).
- If you have to close a CD before maturity, the early withdrawal penalty may eat into the principal. One example is a CD with an early withdrawal penalty of 6 months of interest. If you close the CD 2 months after you opened the CD, you'll not only lose all 2 months of accrued interest, but also you'll lose some of your principal equal to 4 months of interest.
- Early withdrawal penalties for CDs are often more severe than 6 months of interest. Due to the low interest rate environment, banks have been making big changes to the early withdrawal penalties. One recent example is Bank of America's new early withdrawal penalties. One couple was charged a penalty equal to 14 times the total interest the CD would have earned if they held the CD to maturity (see post)
- There is some risk that the bank or credit union could increase the early withdrawal penalty before the CD matures. This recently happened with one credit union (see post). Another risk is that the bank or credit union may refuse an early withdrawal request. I have more details about this risk in my details of CD early withdrawal penalties.
- CD rates don't always lock at the time of the application but when the bank receives your funds. You have to be especially careful if you have to mail in the application and check. The more friendly banks will lock the rate at the postmark date of your mailed check. Some will give you a certain amount of time to send in the check after your submit the application online. One example is Ally Bank which has a Ten Day Best Rate Guarantee. If you fund within 10 days of opening your account, including the day you open, you will receive the highest rate Ally offered during that period.
- When you include one or more beneficiaries, banks often don't specify Payable on Death (POD) or In Trust For (ITF) correctly for purposes of additional FDIC coverage (see post). And sometimes they don't specify the beneficiary at all. Make sure to review how the bank specifies the beneficiaries.
Do you have other tips and potential gotchas for CD investors? If you do, please leave a comment.