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American Banker Op-ed: Banks Need Larger CD Early Withdrawal Penalties


Bankers have noticed that interest rates are starting to rise, and they’re warning their colleagues that CDs with mild early withdrawal penalties can be costly for them. This was the message from an American Banker opinion piece, Banks Should Make It Harder to Withdraw CDs Early (Thanks to the reader who emailed me this article).

We have already seen many banks raise their early withdrawal penalties. I would expect to see more increases in the future. However, the article did not suggest bankers increase early withdrawal penalties on existing CDs. In fact it suggested that changes should only be made when CDs renew:

Existing CD customers should be sent a notice concerning the changes in the early withdrawal penalty that will become effective when their CD renews.

Fortunately, most institutions which have been raising their early withdrawal penalties haven’t raised penalties on existing CDs. There have been two important exceptions (see post).

In addition to providing this warning, the article described some history that I wasn’t aware of. According to the article, there used to be regulations that restricted early withdrawal penalties:

Many years ago the Federal Reserve eliminated the regulations regarding early withdrawal penalties on CDs. Today, banks can establish any structure for their early withdrawal penalty.

It also described what happened back in 1981 when interest rates skyrocketed:

On July 1, 1980, the average rate on a six-month CD was 8.73% and in July 1, 1981 it was 17.40% – over an 800 basis point increase in 12 months.
During this 12-month period, customers were coming to the bank and cashing CDs they had purchased only 30 to 60 days prior because it was cost effective to pay the early withdrawal penalty and reinvest at a higher interest rate.

I was only a child back then, but I remember my parents buying a 10-year 16% CD around this time. I don’t remember if they broke any CDs to fund this 10-year CD.

The article concluded by warning bankers that early CD closures should not be “cost effective” for CD customers. Some of the recommendations included raising the early withdrawal penalty to 12 months of interest for terms of 2 years and longer or to 50% of the term which would be 30 months of interest for a 5-year CD.

The article makes it clear that we should expect larger early withdrawal penalties. It’s important to not only review early withdrawal penalties when shopping for new CDs but also when you’re renewing a CD. When the CD renews, there may be a new penalty in addition to a new rate.

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Shorebreak   |     |   Comment #1
"Many years ago the Federal Reserve eliminated the regulations regarding early withdrawal penalties on CDs. Today, banks can establish any structure for their early withdrawal penalty."

It's the 'Wild West' now regarding EWPs. CD customers need to read the fine print very carefully in the deposit disclosures. This American Banker op-ed article appears to be much ado about nothing regarding a situation that will not reoccur as in the example cited of 1981. Either that, or just another push to squeeze more fees and penalties out of the customer. I believe it's the latter. Regardless the motive, remember it's 'Caveat Emptor'.
Cracker   |     |   Comment #2
I think any bank trying to increase the penalty in the middle of the term will find themselves getting sued for breach of contract.  I can't see any court allowing them to do this.  Some may be trying, but I expect them to lose in the end.
me1004   |     |   Comment #3
Cracker: At least a couple already have changed the penalty in midterm of the CD -- even without interest rates rising. And as we have discussed in these threads extensively in the past, most all banks and credit unions have clauses in their disclosures, often vague and not obvious, that provide for making changes in midterm. The ones that have changed the EWP in midterm have not reversed that action.
Cracker   |     |   Comment #4
Has anyone attempted to litigate this yet?  Probably not, because interest rates aren't rising at the moment, so few people are bothering to redeem CDs early.  A contract is binding on both parties, not just one.  This will not stand up in a court of law.
Anonymous   |     |   Comment #5
Sometimes your CD agreement contain a binding Arbitration Clause which precludes an easy route to other legal actions. I guess the advice would be to not buy unless you will hold to term regardless of potential EWP changes (kind of hard to do sometimes I know).
ChrisCD   |     |   Comment #6
@Cracker - Law suits are expensive and very time consuming.  Most people don't have the time nor $ to fight a bank.  We dealt with a case where an employee stole funds.  You would think that would be a pretty slam dunk case.  Nope.  It took about 4-years and people had to end up settling for about 76% after lawyer fees.

Bank have to be careful when increasing the penalty.  So many people take that into account when deciding on one CD over another.  So a bank with a lower rate may get the deposit because they also have a lower penalty.  If banks were smart, they would have a tierd structured. 

We have had clients closing some CDs early and so far, we have had no problems.
paoli2   |     |   Comment #7
We can't win in any litigation suit because if you read "all" of the clauses in the CD you may find the one which you will overlook.  However, it gives the bank the control over the money until maturity by a two letter word "if".  If they want to release the money to you early, it is up to them so you either get stuck paying a higher penalty or you wait until maturity.  Even with a higher penalty, if they have that clause in there, you still have given control over to the institution if you get the CD.  Go in knowing and hoping you won't need that money early.
Anonymous   |     |   Comment #8
Are we surprised!  Now that CD rates are gradualing showing the 1st signs of heading upward...the "party" that most banks have had (near free money from the fed or discount window and near zero interest rates on CDs; again..and amazingly since most banks have placed more and stricter penalties on early withdrawals already, it seems some people are looking towards yet another step in post-contractual agreement modifications (aka time depost at a fixed rate) to potentially, in a one-sided mannner; alter existing time deposit agreements (and it is an agreement) to **** the customer.  I had always learned, depending on the state the contractual agreement was consumated in; that in order for a contract, or the terms there of, to be binding was if a contract was equal and preoportional for all parties...that is, a one-sided contract (at least order NY law) may be deemed unenforceable.

Not withstanding a very few (or only 1) Credit Union that the NCUA allow to make such a modification, for the most part, such time deposit agreement (which when online are often not readable until after account opening) , or restrcited; usually have, buried deep in the agreement terms such as "the bank may modify, solely at its discreation any or all terms.  Furthermore, despite even opening a time deposit at a bricks & mortar branch, you may find that (buied again), that the contract is subject to the laws of another state in which the bank matains and office...usually Delaware or South Dakota.

Let the DEPOSITOR BEWARE...or at your due dilegence
ChrisCD   |     |   Comment #9
Most of the people on the front line aren't aware of how the clause reads and they will just close the CD after the penalty is taken out.  This is especially true with larger banks. 

There are some banks out there that regardless of the penalty, they really have no intention of letting you have your funds early.  We have found that to be quite rare.  In our history we have only had problems with two banks honoring a penalty.

We have had clients ask for a letter signed by an officer or branch manager that indicates the penalty will be honored.  We have also had banks provide us letters when they do have such disclaimers indicating that they will honor early withdrawal requests.
MidAtlantic   |     |   Comment #10
I do not understand this obsession with early withdrawl penalties on CDs. You contract with the financial institution to deposit your money for a set time period. If you do not want to run the full period don't deposit the money!

I lived in England for several years and the equivalent products there had no early withdrawls. The only exceptions were death and occasionally some instituitons would allow withdrawals on the grounds of extreme hardship, but that was always a favor not a right.
Anonymous   |     |   Comment #11
Remember that Ally is mostly owned by the US Gov't and I'm sure that they would allow Ally to change EWP policies.
OldGuy   |     |   Comment #12
I no longer rely on early withdrawal rights/penalties in opening CDs because I believe they can be changed by the bank or credit union retroactively.  The only thing I make sure of is that the CD can be closed early and without penalty upon my death, which allows me to maintain the fiction that it is worth at least par.  The institution can change this as well, but if it did, I'd be really angry (from the other side).
ParrisBoyd   |     |   Comment #13
Fees and penalties add credence to the opinion of former Assistant Secretary of the Treasury Paul Craig Roberts that the banks are in deep financial trouble. There's massive bank insolvency, opines Mr. Roberts. Banks are holding bonds, and the low rates are part of a scam designed to drive bond prices up, which has "balanced" the banks' financial books. Mr. Roberts says this can't go on forever, and forecasts big trouble when rates eventually rise, which may be what we're seeing the start of. Scary times. 
scottj   |     |   Comment #14
We will not see the type of increases we saw in 1980, this will be slow and gradual otherwise with the debt the country has it would bankrupt us, Fed will not allow that to happen. I have done dozens of CDs over the years and never closed one early and never would. Having a good ladder means I always have CDs maturing to take advantage of the new higher rates. I kind of look at opening a CD as getting married, for good or bad I'm sticking it out
QED   |     |   Comment #15
Really doubt interest rates will increase as happened back in 1981.  Things are very different now.  America is $17T in debt.  High interest rates would cause the country to collape even faster than presently is the case.  And this is to say nothing of the impact on the stock market.  Interest rates will remanin low into the foreseeable future . . . . because there is no other practical option.
lou   |     |   Comment #16
"Most customers do not ask about a bank's early-withdrawal penalty when purchasing a CD. Therefore, it is not usually a competitive issue among banks."

As long as this is true, banks will do whatever they want with EWP's.
Anonymous   |     |   Comment #17

Credit Union.

Credit Union.

Credit Union.

Not that SOME of them aren't just like the banks on this (ie, Fort Knox, etc).. but the VAST MAJORITY of Credit Unions are SO MUCH BETTER than banks. Let your Money do the Walking...
Anonymous   |     |   Comment #18
If rates go up I think that even CU's will change their tune when it comes to EWP.  A good lawyer who writes agreements or contacts will always leave outs for their clients

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