No one likes the idea of locking into a long-term CD in today's awful interest rate environment. However, there might not be any better alternatives for your safe money. No one knows how long these low rates will last. If it lasts longer than expected, today's long-term CDs will be a better choice than keeping that money in a savings account while you wait for higher rates.
One thing that can help reduce the worry about long-term CDs is the ability to make an early withdrawal. You'll have to pay a penalty, but if the penalty isn't too harsh, it could be a good move if interest rates have shot up.
Not all long-term CDs are created equal. Some banks and credit unions can make it difficult and costly for you to redeem a CD before maturity. The most worrisome case is if the bank refuses an early withdrawal request. Some banks and credit unions give themselves the right in their disclosures to refuse an early withdrawal. I reviewed some of these banks and credit unions in my post Inflation Dangerous Banks - Those That Could Refuse CD Early Withdrawals.
Another worry is the bank or credit union increasing the early withdrawal penalty on your existing CD. There have been examples of this at two credit unions. The last one was at CEFCU (see post).
In this post my focus is on some banks and credit unions which offer top CD rates but have early withdrawal penalties that are larger than average. I link to the institutions' disclosures, but make sure you request the latest disclosure from the institution before opening the account.
Melrose Credit Union
Melrose Credit Union has a long history of being a CD rate leader. The credit union allows anyone to qualify for membership so it might seem its CDs would be perfect for CD investors. However, one important downside is a harsh and confusing early withdrawal penalty. Here's what is stated in Melrose June 2010 disclosure:
18-60 Months term: Forfeiture of the first 180 days Dividend and a Reduction to the Share Savings Rate at the time of purchase.
Currently, Melrose Credit Union's share savings account rate is 0.75%. So it appears that if you redeem the CD early, it would be like you had invested in a CD with a 0.75% rate. On top of that you would forfeit 180 days of dividends.
Bank of America
Bank of America rarely has top CD rates, but its 10-year CD rate has been competitive. For those who prefer brick-and-mortar banks, it's a good alternative to Discover's 10-year CD. However, BofA's early withdrawal penalty is harsh. According to BofA's disclosure:
For cds with terms of 12 months or longer, the penalty is an amount equal to $25 plus 3% of the amount withdrawn
Currently, BofA's 10-year CD rate is 2.30% APY. So the EWP would equal over 15 months of interest. That's actually not too bad. As a comparison, Pentagon Federal Credit Union's 7-year CD has an early withdrawal penalty of one year of interest. However, BofA's penalty becomes much worse when CD interest rate falls. For example, its current 5-year CD rate is 1.11% APY. So a penalty of 3% would equal about 32 months of interest.
US Bank has long offered a very competitive 59-month CD special (currently 2.00% APY). Unfortunately, the early withdrawal penalty is harsh. According to the US Bank disclosure:
If your account has an original maturity greater than one year, the penalty will be the greater of either A or B, plus a $25 early withdrawal fee.
A. One-half of the interest that would have been earned on the funds withdrawn if held for the entire term.
B. 3% of the amount withdrawn.
At best the penalty will be as costly as Bank of America's EWP. At worst, it will be larger due to case A. If one-half of the interest earned on the entire term is larger than 3%, that will be the penalty. That's the case for the 59-month CD special. Thus, the EWP is equal to 29.5 months of interest on the amount withdrawn plus a $25 fee.
As you can see, early withdrawal penalties can be costly. In addition, you can lose some of your CD principal. So you could end up with less than what you started with.
If you do need some money from the CD, you should check if you can withdraw accrued interest from the CD. This is the case when you have interest added to your CD. Many banks and credit unions allow you to withdraw all accrued CD interest without a penalty. I have some other tips and issues of early withdrawal penalties in this blog post.
If you have a CD ladder, you may have no plans for an early withdrawal. Nevertheless, you never know what the future will bring. So it makes sense to factor in the early withdrawal penalties when deciding on CDs. I reviewed some of the best long-term CDs with mild early withdrawal penalties in this blog post.