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Issues of Long-Term CDs and Early Withdrawal Penalties

With the historic rate cut by the Feds, banks have begun slashing deposit rates. There are still some opportunities to lock into a high rate but most of these CDs have long terms of up to 5 years. Are these good deals?

There are two economic possibilities to consider: one that favors long-term CDs and the other that makes them undesirable:
  • PRO: Rates will remain low for many years similar to what happened in 2001 in the US and in Japan through the 90's
  • CON: All the money being pumped into the economy by the US government will lead to high inflation at some time between 1 and 5 years from now. This will force substantial increases in interest rates similar to what happened in the early 80's when CD rates were over 15%.
I can't say which is more likely to occur. One thing to consider is if rates do remain low for a long period, you may have no options to find decent rates when your short-term CDs mature. If you are locked into a long-term CD and rates rise, you usually have the option to do an early closure of the CD. It'll cost you an early withdrawal penalty, but it may be worthwhile if you can get another CD at a much higher interest rate.

The typical early withdrawal penalty for long-term CDs is around 6 months of interest. The smallest I've found is 3 months of interest. Some have penalties as high as half the term in interest. This would be 30 months of interest for a 5-year CD. The shorter the penalty, the less cost it'll be to close the CD and re-invest it into a higher rate CD.

Can banks refuse an early withdrawal request?

The other concern that some readers have mentioned is when the bank has a clause in their disclosures that state they have the right to refuse an early withdrawal request. Penalties would apply only if they consent on the withdrawal.

I haven't seen cases where banks have used these clauses to prevent customers from making withdrawals. It appears this is rarely used by banks. But since it's in writing, it is possible, and it is a legitimate concern.

I asked Chris at Jumbo CD Investments about this, and 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.

Chris had a good recommendation when banks have this small print about restricting withdrawals:
Some of our clients would issue a letter and have the bank sign, indicating that they would allow for the closure at the stated penalty. This is quite effective. Most banks are willing to sign because they really don’t intend to not allow the withdrawal.

If you have experienced banks that have refused early withdrawals from CDs or if you had success with such letters, please leave a comment.

To find some 5% 60-month CDs that are still widely available as of the morning of 12/18/08, please refer to my previous post.
Related Pages: CD rates
  |     |   Comment #1
Ken, thanks for the mention of our company. We are a fee based company, but occassionly we have banks we work with that are paying us.

If anyone has more questions about Early Withdrawal Penalties, I'll be glad to answer them. You did a a great job on the post. Of course, you always do. :O)
  |     |   Comment #2
I have a jumbo CD coming due on January 20, at which time I expect there will be no 5% CDs for any term. Wondering if anyone thinks the Vanguard GNMA Fund is a decent parking place for cash at the present time.
  |     |   Comment #3
GNMA funds have done OK so far this year (just below 7% total return for 2008) unlike most of the other sectors of the stock market. Several financial advisors suggested the Inflation Protected Bond funds, but those have slid into negative returns this year with inflation no longer a major concern. I did invest in a GNMA fund back in the 1980's when interest rates were very high. The NAV fluctuates and will be impacted by interest rate movements. If you cannot stomach a loss of your money in case you needed to close out the account, I would not invest in them. Although given the current downward trend in rates, the chance of a decreasing NAV is minimal at this time. The other factor that impacts the performance of these funds is the makeup of the mortgages. If rates drop and people refinance, then the underlying poertfolio securities' income will drop and impact your final total return.
  |     |   Comment #4
I thank Anonymous at 3:19 pm for the commentary on the wisdom of investing in the GNMA funds in this rate environment.
  |     |   Comment #5
You are welcome. Looking back at the start of 2008, I opened a Roth IRA that so far this year has lost 40% of the money that I put into it. Had I placed it into a GNMA fund, I would have gained money instead this year. But, hindsight is 20/20.
  |     |   Comment #6
I have been thinking about whether to go short or long term with cd's. Don't you think with the amount of national debt the government will be incurring the rates will have to remain low for years and that it would take a hot economy with double digit inflation threats for rates to go back up significantly?
I am even considering some 120 month rates because they are above average for the past 10 years. Give me some reasons not to go long in this environment? I may also list my 80 year old mom on the cd so if she passes I have the option of pulling the cd.
  |     |   Comment #7
Another little known possibility is that the bank may "call" the CD anytime before maturity.
I have personally encountered this clause in the "fine print" of FNBO Southwest.
When challenged, the bank manager said it was standard bank language even though, in thirty years of banking, I had never heard of such a thing.
It means the bank reserves the right to redeem the CD at any time, and only has to notify you seven to thirty days in advance.
  |     |   Comment #8
About half a year ago, I have requested a written note from a manager at Fort Knox regarding early withdrawl penalties. Here is the text of email that she sent me:


"Please be advised that the only time we (The Fort Knox FCU) would not give consent of the member to withdraw their CD is if they owe the Credit Union money. There is a penalty of 90 days of dividends if earned or not if funds are with drawn prior to the maturity date.  "
  |     |   Comment #9
If the bank disclosures are silent on whether the bank has the right to refuse early withdrawal request, does that mean they are legally required to grant all early withdrawal requests? More often, the disclosures do not state the bank has the discretion to refuse but does not state the account holder always has the right to withdrawal early subject to bank penalty either.  Are banks required to disclose the bank's right to refuse early withdrawal if that is bank policy? 

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