I don't know how long it will take, but interest rates will eventually rise. If rates do rise like they did in the early 80's, you won't want to be locked into a long-term CD paying today's extremely low rates. If the CD has a reasonable early withdrawal penalty, it should be easy for the depositor to do an early closure of the CD, take the penalty and reinvest the money into accounts with the new higher yields. As we have discussed many times, there are two potential gotchas to this approach:
- The bank refuses to allow an early withdrawal
- The bank increases the early withdrawal penalty on your existing CD
The risk that a bank refuses to allow an early withdrawal is more worrisome since it totally locks the depositor into the CD until maturity. There have been cases of banks refusing an early withdrawal. In my 2008 blog post, I reported on the experience of Chris at Jumbo CD Investments. He remembered two cases in which a bank refused to release funds. In one case, the bank ended up working with him and his client. They were able to have the bank release the funds after negotiating a higher penalty. The other bank would not budge, and it refused to release the funds.
Banks have little reason to refuse early withdrawals in today's environment of falling interest rates. If rates start rising, banks will have more incentives to refuse especially if rates rise substantially.
Last year I reviewed banks that include in their disclosures a clause that gives them the right to refuse an early withdrawal request. Some common clauses that I've seen will include language like "only with the consent of the bank" or "if we permit an early withdrawal of principal".
Most banks and credit unions have disclosures that neither state they may refuse an early withdrawal nor state they will allow an early withdrawal. The best institutions are those which explicitly state that they will allow an early withdrawal. This is typically in the section of the disclosure that describes transaction limitations for the CDs. If you're concerned about being locked into a long-term CD, you may feel more comfortable with these institutions. Unfortunately, I haven't found many. Below is a list of a few of these institutions with excerpts of the disclosures.
- Barclays just started an internet bank with online CDs. As I mentioned in my review, Barclays states the following in its disclosure: "You may, subject to an early withdrawal penalty, make withdrawals of principal from your CD Account before maturity."
- Nationwide Bank has its terms and conditions online, and in the CD transaction limitations sections it states: "You may make withdrawals of principal from your account before maturity. Principal withdrawn before maturity is included in the amount subject to early withdrawal penalty."
- Northwest Federal Credit Union has its certificate disclosure at the bottom of its CD application. In the transaction limitations section, it states: "After the account is opened, you may make withdrawals subject to the early withdrawal penalties stated below."
- Justice Federal Credit Union has the following in the transaction limitations section of its membership booklet: "For all accounts, after your account is opened, you may make withdrawals subject to early withdrawal penalties stated below."
There may be other institutions with this disclosure language that I have missed. If you know of others, please leave a comment. Also, please include a link to the disclosure if you can find it.
This is just one more issue to consider when you're shopping for CDs. For other important CD issues, please refer to my post 10 Gotchas to Avoid for Bank CD Investors.