Here's What Happens When You Make an Early CD Withdrawal

Certificates of deposit (CDs) are looking pretty good right now, with some of the best rates hovering near 5%. That could put quite a bit of interest in your pocket, but to earn it, you usually have to agree not to touch your money for an extended period of time, known as the CD term.

Taking your money out early carries consequences, but it could be worth it in some situations. Here's what you need to know.

What are CD early withdrawal penalties?

In order to earn the competitive rates the best CDs offer, you have to leave your money alone for the entire CD term. This could be anywhere from a few months to several years, depending on the CD you choose. Technically, you can take the money out sooner, but you'll face an early withdrawal penalty.

Each bank sets its own penalty. It's usually equal to several months of interest on the CD. For example, if you have a one-year CD with an early withdrawal penalty equal to three months of interest and you take your money out of the CD after three months, you'd lose all the interest you'd earned so far and walk away with just your principal. If you took your money out before three months, you could lose some of the money you put into the account as well.

Typically, CDs require you to withdraw all your funds at once, so you're also missing out on the additional months of interest you could've had if you'd left the CD untouched. That's why it's usually best not to keep your emergency fund or cash you need ready access to in a CD.

Does an early CD withdrawal ever make sense?

It's best to avoid early CD withdrawals whenever possible so you don't miss out on all that interest. But there are a few scenarios where it might be the lesser of two evils, including:

• When you don't have an emergency fund: Building an emergency fund should be your top financial priority if you don't have one already. But if you find yourself without one and you have money in a CD, tapping it early could be a better choice when you're in a bind than taking on debt.
• When rates climb significantly: Your CD rate is typically locked in for the full term. This isn't always ideal when rates are rising, because you could get stuck earning a lower rate. You can often avoid this by choosing the right CD term based on your finances and the current market conditions. But if you lock yourself into a long CD term that you later regret, the interest you earn by switching to a CD with a higher rate could negate what you lose from an early withdrawal.

How do you avoid early CD withdrawals?

There are a few ways you can avoid early CD withdrawals if you're worried about them.

Choose the right term length from the start

The easiest way to avoid a penalty is to choose the appropriate CD term for you right away. Think about how soon you'll need to access your funds and try to choose a CD term that is shorter than that so you can withdraw your cash freely when the time comes.

As discussed above, interest rates can also play a role in your decision. Generally, you don't want to lock yourself into a long-term CD when rates are rising, but this can be a smart move when rates are falling.

Consider a no-penalty CD

No-penalty CDs are CDs that enable you to withdraw your money at any time without an early withdrawal penalty. These types of CDs are less common than standard CDs, and they may have lower interest rates. But if you're worried about potentially incurring a penalty, this could be the way to go. You will still have to withdraw all your money from the CD at once, though.

Make a CD ladder

CD laddering is a technique that helps you maximize your earnings while still giving you regular access to your funds. It involves opening multiple CDs with different term lengths. For example, you might open a one-, two-, three-, four-, and five-year CD with equal amounts of money in each. When the one-year CD matures, you can either take your cash out or invest it in another five-year CD to take advantage of the higher rates long-term CDs usually offer.

This strategy often requires quite a bit of money, and you're still locking up your money for a while. But you'll have a little more flexibility than you would if you placed all your extra cash in a single long-term CD.

If the options above don't appeal to you, then a CD may not be the right home for your money right now. Instead, consider opening a high-yield savings account that enables you to access your cash at any time.