CDs Can Be Risky. Is a No-Penalty CD a Safer Bet?

The benefit of putting money into a CD is that you might score a higher interest rate on it than you would with a regular savings account. Plus, that interest rate is guaranteed.

You may, for example, currently be getting 4.00% in your savings account. But if interest rates drop in the next few months, by the end of the year, you may only be looking at 3.00%. On the other hand, if you lock in a 12-month CD right now at 4.75%, you're guaranteed that 4.75% for a full year.

That said, there's a risk you take when you open a CD, and it's the risk of a penalty for cashing out your money ahead of your CD's maturity date. The amount you're penalized for doing so depends on your bank and the length of your CD. For example, you could be penalized three months' worth of interest if you take an early withdrawal from a CD with a term of 12 months or less.

But what if you could somehow open a CD that doesn't charge those penalties? Actually, that option exists. But whether it's the right one for you is questionable.

Should you look at a no-penalty CD?

As the name suggests, a no-penalty CD is a CD that allows you to withdraw your money at any time without paying a penalty. You may, depending on your bank, have to give a certain amount of notice before tapping your CD. But generally, you'll avoid being penalized if your financial situation changes and you find that you need your money ahead of your CD's maturity date.

At first, a penalty-free CD might seem like it gives you the best of both worlds. But one thing you should know is that you may end up with a considerably lower interest rate on a no-penalty CD than a regular one.

See, banks reward CD holders with higher interest rates than savings accounts because CD owners are effectively committing to keeping their money put for a period. With a no-penalty CD, you're making much more of a low-level commitment. It can be argued that you're not even making a commitment at all. So expect to earn less on your money as a result.

Alternatives to a no-penalty CD

While a no-penalty CD could end up being a good place for your money, there are some alternate routes you can explore. One option is to shop around for a great rate on a regular high-yield savings account. You may find that you can do better than a no-penalty CD.

Another move to consider is building a CD ladder. With a CD ladder, you have money in CDs that do charge penalties. But you also have CDs coming due at different intervals during the year so that your chances of incurring an early withdrawal penalty are lower.

Opening a CD can be risky, because if you end up with a sudden need for cash, you could be forced to tap that CD early and get hit with a penalty as a result. A no-penalty CD can mitigate that risk, but you might have to give up a higher interest rate to get it. So you may find that laddering solves your problem and makes you feel comfortable with the idea of moving forward with CDs.