What is the best time to break a CD early for a better rate?

The golden rule for certificates of deposit is this: Do not withdraw before the CD term expires. If you do, you will be penalized.

Sometimes, breaking the rules can pay off.

“If interest rates are low, and then rise substantially, it may make sense to close a CD early,” Andrea Brashears–Lusk, a certified financial planner who is also the president and founder at Wise Financial Counsel, Fort Washington, Maryland, said in an email.

To determine if you can break your CD, you should check the math. This will show you what you would lose on an existing CD as well as what you get on a new CD. This can be done using online calculators.

Let’s get in.

Let’s say that your CD is working well. We’ll talk about other investment options in a later article. A CD is an investment that you put upfront and can withdraw at any time. A CD typically has a fixed rate, which means you have a guaranteed return.

However, in a rising-rate environment a CD’s fixed rates have a downside. You lose out on CDs with higher rates.

The national average rate for one-year CDs is 90.90% , as compared to January 2022’s 0.13% according to Federal Deposit Insurance Corp.

Let’s find out if it is a good idea to withdraw from your CD and get a brand new one

Two costs are usually associated with early withdrawals from CDs: the bank’s penalty and any interest earned if you keep that CD until maturity. To calculate both the penalty and the cost of early withdrawal, use this calculator.

A CD with a 5-year term and a 1% annual percentage return is $10,000. The total interest you can earn if you keep the CD in good standing until maturity is $510. Instead, you can withdraw the CD when there is one year remaining. Your bank may charge a penalty equal to one year of simple interest.

If slightly rounded, the penalty would be around $100. The total future interest (the value of the last year) would be approximately $200. Combined, you lose $300.

Your withdrawal balance, which includes your initial deposit, equals $10,210. This is compared to the $10,510 that you would have earned over a full term.

Look for a CD that has a higher interest rate to see how much interest you could earn if you keep the CD for its full term. To help you, use a CD calculator.

You can continue the same scenario by placing your $10,210 withdrawn balance into a new five year CD with a rate of 4.4%. After minor rounding, the total interest you would earn over five years is $2,210. Your future balance would be approximately $12,420

Add the interest you would earn on the new CD to the cost of the old CD. You would have to pay the cost of the old CD, which includes the penalty for early withdrawal and future interest loss.

Old CD losses (which include Penalty + Future Interest lost)

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  If your result is positive, it would be a good idea to break the first CD sooner. The second CD would allow you to recoup your loss and make more money.
  

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  Hold onto the CD until it matures if the result is negative. This will ensure that you don’t lose more money than what you gain.
  

$2,210 – $300 = $1,910

It is easy to compare the returns of CDs because CDs have fixed rates. (Exceptions to this rule are step-up or bump-up CDs. Future gains can be calculated with high confidence. However, future returns from the stock exchange fluctuate greatly, and rates on regular savings accounts can change over time.

Bonds can, however, have fixed interest rates. This allows you to compare CD returns with other types of bonds such as Treasury bonds and notes. Bonds are different enough from CDs to be considered a separate part your overall savings and investment portfolio. They may also play a role in your savings goals differently to CDs.

A CD is for a specific amount of money and should not be part of your daily savings or long-term investment portfolio. An emergency fund that can cover several months of living expenses is better placed in a high-yield savings bank.