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Are You Ready for a Cashless Society?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.
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'.
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.
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 least...do your due dilegence
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.
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.
As long as this is true, banks will do whatever they want with EWP's.
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...