Wisdom of Long-Term CDs in Today's Rate Environment?
I've heard many people advise against buying long-term CDs in today's low-rate environment when there appears to be the possibility of much higher rates in the near future. This is reasonable, but it's important not to forget the risk that rates will stay low for two or more years. If rates do stay low, you'll miss out on higher rates that were available on the long-term CDs.
There is often too much concern over early withdrawal penalties. These penalties are not always too severe. For example, Pentagon Federal Credit Union is currently offering a 5-year CD with a 3.50% APY. The early withdrawal penalty is up to 6 months of interest. If rates start to spike a year from now and you want to break the CD, the result would be a loss of 6 out of the 12 months of interest that you had accrued in the CD. This makes the 1-year effective APY to be about half of 3.50% (1.75%). This isn't too bad when you consider this is higher than many 1-year CD rates from internet banks.
There is one risk when planning on an early withdrawals. Some banks have small print that gives them the right to refuse an early withdrwal request. Banks rarely make use of this right, but there have been cases where this has happened. I described some examples in this post on long-term CDs. If rates do shoot up, some banks may decide to enforce this right especially if they're having problems financially.
For Pentagon FCU, I can't find any small print in which they say they could refuse an early withdrawal. I have more details on PenFed CDs in this recent post.
OneWest Bank also has a fairly competitive 5-year CD with a 3.30% APY as of 1/20/2010. The penalty is 6 months of interest. Also like PenFed, I can't find any small print in OneWest's disclosure that gives them the right to refuse an early withdrawal. Refer to my OneWest CD review for more details.
Banks Mentioned in this Post:
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