A sneaky way to get a better interest rate on your CD

It looks like the crazy-low interest rates on savings and CDs aren’t going to improve any time soon.  The Fed has indicated that they plan to keep rates low for the foreseeable future.  And, frankly, our federal government just can’t afford to let interest rates rise because of the ballooning federal debt.

So, what’s a suffering saver to do?  Here’s a trick to improve your interest rate on a 2 year CD.  And, the tip also works for other medium length CD terms.

What’s the trick?  Buy a 5 or more year CD and pay the withdrawal penalty if you need the cash earlier than that!

An Example: Investing $10,000 for 2 Years

Let’s look at the math.  I’m using the rates from as an example.  (Rates as of October 25, 2011).

  • 2 Year CD: 1.25% APY
  • 5 Year CD: 2.00% APY
  • 10 Year CD: 2.50% APY

Now, we need to look carefully at the early withdrawal penalties:

  • CD term of 1 to 5 years: The penalty is 6 months simple interest on the amount withdrawn.
  • CD term of more than 5 years: The penalty is 9 months simple interest on the amount withdrawn.

If we deposit our $10,000 in a 2-year CD, and withdraw the balance after 2 years, we’ll earn $251.56 in interest.

Invest the same $10,000 in a 5-year CD, and after two years the interest is $404.00 but when we withdraw we owe a penalty of 6 months interest on the $10,404.  That penalty is $10,404 * 2% * 6/12 = $104.04.  Our total profit is $404.00 – $104.04 = $299.96.  That’s an effective APY of over 1.48%.  Nice boost.

What if we use a 10-Year CD instead to get the top rate of 2.50% APY?

After two years at 2.50%, our balance is $10,506.25.  Our penalty is 9 months interest now, equalling $197.  Profit of $309.25 is even better than before.  An effective APY of over 1.53%.

Obviously you will need to do a similar analysis for your particular situation, but you’ll often find that you can gain the benefit of the higher rates from a longer term, and still come out ahead even if you have to pay an early withdrawal penalty.



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