What are “No Penalty” CDs?

Have you ever wished you could lock in a competitive, guaranteed rate on your savings while still retainign the flexibility to access your cash in a pinch? If so, then you might be interested in a so-called “No Penalty” certificate of deposit (CD).

What is a “No Penalty” CD?

“No Penalty” CDs are exactly what they sound like — CDs that have no penalty for early withdrawal. In the case of traditional CDs, you typically forfeit a portion of the interest that you’ve earned (often 3-6 months worth, but sometimes more) if you break your CD prior to maturity.

Given the above, “No Penalty” CDs can be a great option in a falling interest rate environment because you can lock in a decent rate but still have access to your cash. Alternatively, in a rising interest rate environment, they give you the freedom to switch to a higher rate.

What’s the downside?

As great as “No Penalty” CDs sound, there are some downsides and limitations. For starters, the rates on “No Penalty” CDs are somewhat lower than traditional CD rates. In some cases, they might be no higher than online savings account rates.

In terms of minimums, some banks require high minimum deposits for their “No Penalty” CDs, in some cases ranging as high as $5k-$25k. Fortunately, others don’t. Thus, it’s important to look closely at the terms when considering your options.

In addition, despite their “No Penalty” moniker, there might still be some limitations on how/when you can access your money. For example, while some banks allow you to pull your money back out within a week or less, others require up to 30-90 days.

Finally, “No Penalty” CDs are typically short-term CDs. In the vast majority of cases, we’re talking 9-12 months, or even less. This means that the rates won’t be all that high, as shorter-term CDs have lower rates.

Where can you get “No Penalty” CDs?

“No Penalty” CDs are offered by a variety of banking institutions. As noted above, rates and terms vary, so it pays to shop around. One bank with particularly good terms is Ally Bank, who offers “No Penalty” CDs with no minimum deposit requirement, a relatively narrow spread between their traditional and no-penalty CD rates, and you can access your money within six days of opening the CD.

Alternatives to “No Penalty” CDs

While “No Penalty” CDs can be a great deal for some, they’re not necessarily for everyone. For example, if you don’t have a lot of money, it might not be worth going to the trouble of opening CDs vs. simply using a high-yield online savings account, especially given the relatively flat interest rate landscape right now.

In our case, we’ve opted to stick with the tried-and-true CD ladder approach. We’ve built a five year CD ladder with one CD corresponding to 20% of our holdings maturing each year. This gives us a bit of flexibility while smoothing out the inevitable ups and down of interest rates. Our longer time horizon has also allowed us to lock in higher rates than would otherwise be available.

If you’re a bit more risk tolerant, another possibility would be to invest with Lending Club, which offers three year notes paying an average of 9.5% annually (my review). Because Lending Club has a note-trading platform, you can actually sell your notes to other investors mid-stream, providing a bit of liquidity.