Last week when Ally Bank introduced several new products including IRAs, I was a little disappointed Ally Bank didn't come out with longer-term CDs. I had thought they may want to better compete with Discover Bank which offers 7-year and 10-year CDs and IRA CDs. Ally's longest term continues to be 5 years.
You might think even a 5-year CD is way too long in today's environment in which interest rates could shoot up any month due to inflation or a debt crisis. However, this fails to consider the early withdrawal option for CDs. It also fails to consider the other risk: rates stay low for many years.
There are worries that banks could increase early withdrawal penalties or make it more difficult for customers to leave a CD if interest rates shoot up. As I described in this post, a credit union has already done this.
When we first learned of Ally Bank's early withdrawal penalty of only 60-days of interest, several readers were informed by Ally Bank reps that Ally had the right to change the early withdrawal penalty on existing CDs with 30-day notice. I investigated this, and received assurance from Ally Bank's public relations director that Ally would not change the early withdrawal penalty on existing CDs (see post). Of course, this doesn't eliminate the risk. To reduce the risk that all of your money will be stuck in low-yield long-term CDs if rates shoot up, you might want to consider CD ladders and using multiple banks and credit unions.
For terms of 5 years and under, Discover Bank CDs don't offer any advantages over Ally Bank CDs. Discover may have a slight edge on some of these CD rates, but the early withdrawal penalty is larger. Ally's EWP is 60 days of interest for all terms (see Ally's account disclosure). Discover Bank's EWP is described in its FAQ page and is as follows:
- 3 months simple interest on the amount withdrawn for terms under 1 year
- 6 months simple interest on the amount withdrawn for terms from 1 to 5 years
- 9 months simple interest on the amount withdrawn for terms over 5 years
Discover Bank has an advantage for terms over 5 years. The rates are higher. Of course the term is longer and the penalty is larger so you will have to do the trade-off analysis. On the plus side, the 9-month EWP isn't that bad for terms over 5 years. Many institutions have a penalty of 12 months or more of interest for terms over 5 years.
To help you make that trade-off analysis, I did another early withdrawal yield table. I compared Discover's 5-year and 10-year CDs with Ally's 5-year CD. I listed the effective yields when the CDs are closed early for each year after account opening. The yields take into account the early withdrawal penalties. As you can see, Ally Bank's 5-year CD has the best rates before 3 years. Discover Bank's 10-year CD takes the lead at 3 years.
The early withdrawal yields listed below are based on the spreadsheet developed by Bogleheads forum members. It's available from the Bogleheads Wiki: Comparing CDs. It should be noted that the following simple formula comes very close to this spreadsheet:
Post Penalty APY = (Full APY) x (D - P) / D
D = days into term when the CD was closed.
P = days of the early withdrawal penalty
These CD rates are based on the rates listed at the institutions' websites as of 6/27/2011:
Approximate Yields After Early Withdrawal Penalties
|Year of Early Withdrawal||Discover's 10-yr 3% CD||Discover's 5-yr 2.35% CD||Ally's 5-yr 2.34% CD|
|Early Withdrawal Penalty||9 months||6 months||2 months|
|year 5||2.54%||2.35% (no penalty)||2.34% (no penalty)|
|year 10||3.00% (no penalty)||n/a||n/a|
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