My Personal Finance Journey

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Withdraw Early If You Dare

Contributed by mm | August 14, 2004 9:09 PM PST

According to BankRate, CapitalOne is paying the second highest interest rate on 5-year Certificate of Deposit (CD) with an effective APY of 4.70% for a minimal of $5,000 deposit. Considering the fact that the No. 1 highest paying institution is a much less known regional bank (Intervest National Bank, New York, NY), and the APY difference between the two is merely 0.10%, I can believe many people will opt for CapitalOne.

Read the fine prints and think twice.

It's not uncommon that there is early withdrawal penalty for CD products. Usually, the penalty can be worth three to six months of interest, depending on the length of your CD. Some financial institutions, like NetBank, may charge half of the earned interest. In both cases, normally customer will not be charged for more than earned interest.

It is, however, uncommon how CapitalOne designs its early withdrawal policy:

---------------------------------

You may not withdraw principal from your account prior to the account's maturity date. If we permit early withdrawal, the penalty for early withdrawal for Certificates of Deposit will be assessed as described below:

1. On a CD with a term of less than six months, a penalty equal to one (1) month’s interest on the amount withdrawn will be assessed.

2. On a CD with a term of six months to one year, a penalty equal to three (3) months’ interest on the amount withdrawn will be assessed.

3. On a CD with a term of more than one year:

a. If early withdrawal is made within 6 months of maturity: a penalty equal to six (6) months’ interest on the amount withdrawn will be assessed.

b. If early withdrawal is made 6 months or more before maturity: a penalty equal to the greater of six (6) months’ interest or the Economic Replacement Value (see below for definition) on the amount withdrawn will be assessed.

Economic Replacement Value (“ERV”): ERV is an estimate of the interest cost Capital One would incur if it were to replace a CD that is withdrawn early with another CD having a term that is comparable to the remaining term of the original CD. If interest rates have risen, then the cost of the new CD will be higher.
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CapitalOne actually provided an example in the disclosure: if you make an early withdrawal from an 2.00% APR 5-year CD 27 months earlier than the CD expires, CapitalOne will consult the prevailing 24 month CD product rate. In the example, if the 24-month rate is 2.50%, the ERV will be calculated on the 0.50% rate difference and 27 months, and it will turn to $450 for the original $40,000 principal ($40,000 * 0.50% * 27 / 12).

You may say $450 penalty is still well below the earned interest of $2,200 ($40,000 * 2.00% * (60- 27) / 12). But considering this example: if today you buy a $40,000 5-year CD yielding 4.70% APR, and one year from now you need to back out from the deal after earning one year interest of $1,880 ($40,000 * 4.70%). If, at the same time, the 4-year CD APR, currently at 4.25%, jumped two percentage points (not unlikely in this rising rate environment) to 6.25%, your penalty will be $40,000 * (6.25% - 4.70%) * 4 = $2,480, wiping out your entire interest plus setting you another $600 back. Does this make you think twice?

If you believe you have absolutely no need to make an early withdrawal, go ahead and pursue the high yield. However, if there is even a small chance that you may need the cash earlier than you expect, stay away from CapitalOne's CD product; you don't want to be involved in a transaction in which your loss is literally uncapped.

(This post is part of PFBlog Product Review series. Check out more reviews here.)

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