bank rates

Here’s A Strategy To Make The Most Of Your CDs While The Fed Dithers Over Rates

The fact that no one knows when the Federal Reserve will finally start pushing interest rates higher presents a vexing quandary for savers.

Is it best to go long to secure the least pathetic interest rate?

Or is it smarter to sacrifice yield for a shorter term so you’ll have funds available when better-paying certificates of deposit start popping up?

One potentially winning approach in this ambiguous limbo period is to take advantage of early withdrawal rules.

By starting with the top nationally available long-term yields on our CD Rates Leaderboard and then shrewdly applying an early withdrawal strategy, you can use 60-month CDs to earn chart-topping returns over a shorter period of time.

Here’s how it works.

While CDs are offered with the understanding that you’ll keep the funds deposited until maturity, banks and credit unions almost always provide an out for savers who opt to withdraw their funds early.

You can have your money back if you agree to pay an early withdrawal penalty, or EWP. How an institution calculates that penalty is an important term explicitly stated in every certificate of deposit agreement.

Some banks and credit unions charge relatively stiff penalties that hold back a percentage of your balance plus a flat fee that can actually eat into your principal.

But most charge five to 18 months’ worth of interest, which can be a reasonable price to pay at the low end.

The key to successfully employing early withdrawals is finding a long-term CD from an institution that pays a leading rate and charges just a modest EWP.

When you know those two things, it’s possible to calculate what a CD’s actual yield would be if you cashed out prior to maturity.

We’ve done that for the top-paying nationally available 5-year CDs – all of those paying from 2.25% APY to 1.75% APY – and the results are encouraging.

Top Nationally Available 5-Year CD Rates

Bank Yield Minimum deposit
Barclays 2.25% No minimum
GE Capital 2.25% $500
Synchrony Bank 2.25% $25,000
CIT Bank 2.20% $1,000
First Internet Bank of Indiana 2.12% $1,000
State Bank of India – Chicago 2.12% $2,500
State Bank of India – New York 2.12% $5,000
Discover 2.10% $2,500
Sallie Mae 2.10% $2,500
Ally 2.00% No minimum
BBVA Compass 2.00% $500
Nationwide 2.00% $500
Salem Five Direct 2.00% $10,000
State Farm Bank 1.90% $500
EverBank 1.85% $1,500
VirtualBank 1.81% $10,000
Northwest Community Bank 1.77% $1,000
TAB Bank 1.77% $1,000
AloStar 1.75% $1,000

Twelve of those banks charge a penalty that’s too steep to allow significant gains from early withdrawals.

But seven of them keep just five or six months’ worth of interest.

One of those, TAB Bank, has a yield (1.77%) that’s not a high enough starting point to sufficiently outweigh the incurred penalty.

That leaves us with a half dozen banks whose 5-year CDs can provide significant short-term gains even after the penalty is imposed.

All will beat the top nationally available returns on our CD Rates Leaderboard in just 18 months.

A few will do so after just 14 months.

In other words, if you keep the CD for at least as long as its break-even point, you’ll have done better than you could have done with the very best national CD for that shorter term.

And it gets better. Take a look at the 24-month and 36-month actual yields of these early-withdrawn 5-year certificates, and you’ll see where the gains really impress.

The worst any of these winners does over the 24-month and 36-month Leaderboard rates is 0.11 percentage points, while the gains can be as high as almost four-tenths of a point from Barclays and Synchrony.

This flexibility to choose when to exit a CD based on current market conditions can be an effective hedge against the unknowns of Fed timing, which is a major uncertainty now.

Back in December 2008, the Federal Reserve drastically reduced what’s called the federal funds rate – the interest commercial banks are charged to borrow money from each other through the Fed – to help the economy recover from the Great Recession.

In fact, the Fed dropped the rate all the way to essentially zero and has held it there for the last six years.

That’s allowed banks to get pretty much all of the free money they need for loans through the Fed and slash the amount they pay savers for deposits.

One measure of how little savers are being paid is the Cost of Funds Index compiled by the Federal Home Loan Bank of San Francisco. It asks banks in California, Arizona and Nevada how much they’re actually paying for deposits.

The index hit a record low of 0.663% in September before rebounding slightly to 0.700% at the end of February.

Back in 2008, before the Fed lowered the federal funds rate to zero, it was four times higher at 2.757%.

Now, with the economy improving, the Federal Reserve’s rate-setting committee is preparing to return the fed funds rate to a more normal level – probably something like 3.5%.

That will be a tremendous boon for savers because banks will need our money again.

But when the Fed will start raising rates is impossible to know.

Official statements, speeches and interviews with committee members say the first boost could come as early as June – or not until sometime next year.

The committee continues to emphasize that its decision will be based on the economy, with lower-than-expected inflation and weaker-than-desired wage growth giving some committee members pause.

“The economy is throwing off some mixed signals at the moment,” Atlanta Fed President Dennis Lockhart, considered a centrist on the rate-setting committee, told CNBC recently. “I think that’s going to be passing, or transitory. But the first quarter looks very soft.”

As if making his point, the jobs report released a week ago was a mixed bag. While the month’s job gains were discouraging – the weakest since 2013 – the average hourly earnings (which are closely watched by the Fed) increased favorably.

Wall Street’s odds on when the Fed will raise rates – a probability measured and reported by the CME Group FedWatch – dropped after the Fed removed the word “patient” from its March 18 statement and then decreased further during the past two weeks.

FedWatch currently calculates the probability of the first rate increase occurring in June to be 6%; in July, 16%; in September, 31%; and in October, 48%.

It isn’t until the December meeting that FedWatch’s odds are better than even, at 61%.

With rate increases perhaps another six months or more away, and then likely climbing only slowly after that, locking in a 60-month rate now that offers attractive early-exit options can be a smart play.

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