How to engineer higher CD rates

Don't like today's low CD rates? A little tinkering can help get you a little more out of your CDs.

Beyond the usual techniques to get the best CD rates, some attention to early withdrawal penalties can help you engineer higher interest rates on CDs. You have to be careful though--the environment for those penalties can be treacherous.

Squeezing more out of a CD


Basic techniques for getting the best CD rates include shopping around and tailoring the size of your deposit to get the highest rate a bank offers. The latter has traditionally meant pooling your deposit to qualify for a jumbo CD (over $100,000). But in today's banking environment, there are often special interest rates that are capped at a certain maximum balance, so tailoring your deposits might entail the opposite strategy: spreading your money among different CDs to get more of these special rates.

In any event, if you want to go a step further in working for higher CD rates, you can factor in early withdrawal penalties to change the effective length of the CD you choose. The following are two examples.

Example 1: Make your own shorter-term CD

Some banks offer CDs that don't charge penalties for early withdrawal, at least after a specified period of time. Often, the price you pay for this is a slightly lower rate than on a comparable CD--but then again, if you effectively shorten the term of the CD, you could wind up with a more competitive rate at that shorter term.

For example, suppose you wanted a 2-year CD. You could find a 3-year CD that allows you to withdraw without penalty after two years. If you follow through and do this, you'd effectively have made a 2-year CD investment, only at 3-year CD rates.

Example 2: Taking the hit on the penalty

Even if the bank has an early withdrawal penalty, the penalty amount can be manageable over longer time frames. For example, suppose you want a 4-year CD. You find several in the 2.25 percent range, but your eye is drawn to a 5-year CD at 2.75 percent. The 5-year CD will penalize you two months' worth of interest for early withdrawal, so you can do the math: Two months' worth of interest at 2.75 percent a year comes to about 0.46 percent.

If you've been earning 2.75 percent over the first four years of the CD, withdrawing your money and taking the penalty isn't a bad strategy. Spreading that penalty out over that four years would reduce your effective interest rate to around 2.64 percent--still much higher than you could have found on a 4-year CD at the start.

    What to look for in early withdrawal penalties

    Informed use of early withdrawal penalties can help you get a longer-term CD rate on what you effectively turn into a shorter-term CD, but you have to be careful. Not only do penalties vary, but the way these penalties are structured can have crucial differences.

    Penalties expressed as a function of time--e.g., two months of interest--can be the most manageable penalties, especially if you stay in the CD for a few years. However, other penalties are expressed as a flat percentage (e.g., 2 percent of principal), and these can be very damaging in today's low rate environment. Other fees are a fixed dollar amount, and these are especially onerous on smaller deposits.

    Know what the penalty is and how it's structured. This knowledge may help you engineer a higher CD rate.

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