Should You Break a CD Early to Lock In a Higher Rate?

If you got a certificate of deposit (CD) before 2023, then you're probably looking at today's high APYs with envy and regret. Many of today's top-paying CDs are paying out at rates above 5%, with the very best hovering around 5.50%. That's several percentage points higher than the top-paying CDs in 2022, many of which had APYs in the decimals.

If CDs were like savings accounts, you could just open a new one and transfer the money with few consequences. Unfortunately, banks and CD providers stipulate that you have to keep your money locked up for the duration of your term, unless you want to pay penalties to withdraw early.

But sometimes promises are meant to be broken. And, in the case of an old CD, you might be better off breaking that contract to snag one of today's higher rates. If you're debating it, let's take a look at when it would make sense.

When it makes sense to break your CD early

At risk of oversimplifying, it would make financial sense to replace a low-paying CD if you can net more earnings with a new one. To determine this, however, we'll have to walk through some steps.

First, look at your current CD and ask yourself how much you stand to lose by breaking your contract. Unless you have a no-penalty CD, your contract will likely have an early withdrawal penalty, usually equal to a period of interest, like three months.

Once you figure out the penalty, you should calculate your opportunity cost, that is, the interest you're not going to earn with your old CD. For instance, if you're breaking a 12-month CD six months before it matures, you'd be forfeiting six months of interest. The six months of forfeited interest plus the early withdrawal penalty would be your net losses on this old CD.

Finally, you'll want to calculate how much the new CD will pay you. You can figure this out by multiplying the APY by your savings, then adjust based on your CD term. If we were to put this into an equation, it might look something like this:

New CD earnings - Old CD losses = Net gain or loss

If the result is positive, then you would walk away with a net gain and breaking the CD contract would make sense. However, if the result is negative, then you're losing money, and you're better off keeping your old CD.

Ugh, formulas. Can you just give me an example?

Let's say you've deposited $10,000 into a 2-year CD with an APY of 3.00%. The early withdrawal penalty on this CD is six months of interest, or $150 for your deposit. You've had the CD for 12 months, which has earned you $300.

If you were to walk away now, your net loss would be $450: the $150 penalty, plus $300 in opportunity costs (12 months of missed interest). All in all, you'd still walk away with $10,150 to reinvest.

Now, let's say you're looking at a 12-month CD with an APY of 5.30%. Your opening deposit is $10,150, so you stand to earn about $538 in interest after 12 months. As long as you keep your money invested for the full 12 months, you'd earn about $88 more in this CD than your old one. Here's the math:

$538 - $450 = $88

So yes, it would make financial sense to break that old CD for this new one. Whether it's worth the effort for $88 is a personal decision, but doing so would result in a financial gain.

All things considered, if you've been looking at today's high CD rates through watery eyes, it might be worth doing the math, especially if your old CD has a rock-bottom rate (like 1% or lower). Take a peek at today's top-paying CDs and see if it's worth breaking your contract for a new one.