An important concern with long-term CDs is having your money locked into a low-rate CD when interest rates are shooting up. It's unlikely that we will see interest rates shoot up in the near term, but it becomes more likely with growing budget deficits and increasingly easy monetary policies. Conditions like that could lead to higher inflation, and that could force the Fed to raise interest rates.
I'm sure many readers remember the late 70's and early 80's when the Fed Chairman Paul Volcker raised the federal funds rate to 20% in June 1981. That helped to bring inflation down from its peak of 13.3% in 1979 to 3.2% by 1983 (source: NYT). I remember my parents in the early 80's purchased a 10-year CD with a 16% APY. When it matured, the value was over 4x of the original principal.
Over the last six years I've seen many comments from readers who say they would never lock into a long-term CD due to the above fears. It should be remembered that there's another risk: rates keep falling or stay low. That is what has been happening over the last four years. I remember in 2007 when a lot of people chose FNBO Direct's 6.00% savings account instead of PenFed's 6.25% long-term CDs. Why lock into a long-term CD when you can have a liquid savings account paying almost the same rate? Today the FNBO Direct's standard savings account rate is 0.70%.
Even though rates may continue to fall or stay low, there is a risk that rates will eventually shoot up. 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. However, 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. There are two potential gotchas to this approach that we've discussed many times:
- The bank refuses to allow an early withdrawal
- The bank increases the early withdrawal penalty on your existing CD
I consider the first risk to be the more worrisome. The increase of an early withdrawal penalty is possible as we learned with the Fort Knox FCU case. However, an institution is required by regulations to provide affected members with a written change-in-terms notice at least 30 days before the effective date of the change. At least that gives us a chance to deal with the changes. If the institution is making a big increase in the penalty, customers should be able to close the CD before this change takes effect with the original early withdrawal penalty.
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.
Banks That Are More Likely to Refuse
If you are concerned with being locked into a CD, it makes sense to avoid banks and credit unions which include in their disclosures a clause that gives them the right to refuse an early withdrawal. Unfortunately, several banks and credit unions do have clauses in their disclosures which give them the right to refuse an early withdrawal. 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".
I've reviewed the disclosures of several banks and credit unions. I identified those that include this type of language that gives them the right to refuse an early withdrawal. I also identified those which I did not find this language. Note, it's possible that I missed the clause so it doesn't guarantee that these "good" banks won't refuse an early withdrawal. However, I consider these to be less likely than the ones which have these clauses.
Inflation Dangerous Banks and Credit Unions
I'm calling these "inflation dangerous" since their CDs could be dangerous if we see high inflation and rising interest rates. The danger is being stuck in the low-rate CDs if the banks make use of these clauses in their disclosures. In addition to listing the banks and credit unions, I'm also listing the links to their disclosures and excerpts of these clauses. Please note, banks and credit unions often update their disclosures, and the new disclosures may remove these clauses. That happened recently at iGObanking.com as I documented in my last iGObanking.com CD review. So make sure you check with the bank or credit union for the latest disclosures.
- AIG Bank - disclosure: "Withdrawals from a time deposit prior to maturity or prior to the expiration of any notice period may be restricted."
- Bank of America - disclosure: "Except as required by law, withdrawal prior to maturity will be permitted only with the consent of the bank which may only be given at the time of withdrawal."
- Fort Knox Federal Credit Union - membership agreement: "Withdrawal of the principal amount of your Certificate may be made only with the consent of the Credit Union."
- OneWest Bank - Disclosure statement: "If we permit an early withdrawal of principal, we may impose an early withdrawal penalty on the amount withdrawn as follows"
- USAA Bank - disclosure: "Any withdrawals before the maturity date require Bank's consent."
- U.S. Bank - disclosure: "Except as required by law, withdrawal prior to maturity will be permitted only with the consent of the bank which may only be given at the time of withdrawal."
Note, I only included banks and credit unions in which I could link to an online disclosure with the clause restricting an early withdrawal. If you know of other banks or credit unions with such a clause that's not listed, please leave a comment with the name of the bank and a link to the disclosure.
Inflation Friendlier Banks and Credit Unions
There are a few banks and credit unions with disclosures that explicitly state that early withdrawals of principal is allowed. For example, Northwest FCU has the following clause "you may make withdrawals subject to the early withdrawal penalties stated below". However, most banks and credit unions have disclosures that neither state they may refuse an early withdrawal nor state they will allow an early withdrawal. I've included some of these below. Please note that I don't take into consideration the size of the early withdrawal penalties or if there is any clause that gives the bank the right to increase the penalty on existing CDs. Also, please be sure to check with the bank or credit union for the latest account disclosures.
- Digital Credit Union
- Discover Bank
- Melrose Credit Union
- Nationwide Bank
- Navy Federal Credit Union
- Northwest Federal Credit Union
- Pentagon Federal Credit Union
- Velocity Credit Union