A reader emailed me this Chicago Tribune article, Don't get burned by withdrawing CD early (hat tip to the reader). It describes what happened to a couple who closed their Bank of America CD early for a down payment for a house. They were shocked to learn of Bank of America's new early withdrawal penalty. I described Bank of America's new CD early withdrawal penalty in May. For CD terms over 12 months, the new penalty is 3% of the principal plus $25. The couple's CD term was 13 months, and it had an interest rate of only 0.20%. So the penalty came out to almost 14 times the total interest the CD would have earned if they held the CD to maturity.
With the new harsh penalty, the depositor gets hit twice. First, they get hit by the very low interest rate. Second, they get hit hard if they need the money before maturity. When I first posted on this penalty change, I heard a bank representative make the claim that the new penalty was intended to cover the administrative cost for an early CD closure. That may justify the flat $25 fee that's added to the penalty, but it doesn't justify the penalty of 3% principal.
The author of the article who answered the couple's question also mentioned a few other CD gotchas. One important gotcha is that the early withdrawal penalties at most banks have the potential to eat into the principal. In other words, you will come out with less money than what you put in.
The potential of losing principal is common even with early withdrawal penalties based a number of months of interest. For example, if the early withdrawal penalty is 6 months of interest, and you close a CD early after 2 months, you may not only lose all 2 months of accrued interest, but you may also lose some of the principal equal to 4 months of interest.
List of CD Gotchas
I discussed this issue and more CD gotchas in my March blog post, Important Details of CD Early Withdrawal Penalties. It's important to review the CD disclosure not only before you open a new CD, but also before you let a CD renew. We all know that when your CD matures and is renewed, the interest rate will likely change. It's also important to know that a new early withdrawal penalty may take effect on the renewed CD.
As we learned last week, you can't just open a CD and forget about it. You have to keep on top of all communications from the bank or credit union. They could make changes to the CD before maturity. Last week I described how Fort Knox Federal Credit Union increased its early withdrawal penalty on existing CDs and how the NCUA approved of this change.