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As interest rates on short-term CDs begin to fall, many smart savers will be scrambling to secure high interest rates before it’s too late. While this may be enough for people with plenty of cash on hand, it can present a dilemma for those who are only saving for emergency expenses. Should you raid your emergency fund to secure a high APY, or play it safe and keep it safe? Do you have cash in an account that you can access on demand? It’s tempting, but here’s why I don’t move my emergency fund to a CD.
Why CDs aren’t the best choice for emergency savings
Simply put, CDs aren’t flexible enough to store your emergency funds. Essentially, it’s a contract between you and the bank to keep your money there for a set period of time (such as 12 months) in exchange for a higher-than-average APY. If you break your contract and pay cash early, your CD provider will impose a penalty on you.
yes.you can Losing money on CDs.
Early withdrawal penalties for CDs vary by contract, but are usually equal to the interest you earn over a period of time. For example, an 18-month CD could be subject to 180 days of interest if you withdraw it before maturity. So if he deposits $50,000 into this 18-month CD with 5% APY, he would have to pay about $1,250 to cash out early (assuming the bank evaluates interest daily).
If you keep your money for the duration of the contract, you’ll earn around $3,750. Not bad, but again, you have to risk going that entire period without tapping into your emergency savings.
Here’s a scenario that could really sting. Let’s assume you get his 18-month CD at 5% APY and agree to an early withdrawal penalty equal to 180 days of interest. You will need to access your savings after 3 months, so request an early withdrawal. You’ve earned three months’ worth of interest (about $625), but you still have to pay a penalty amounting to 180 days, or about $1,250. To perform an early withdrawal, you’ll need to pay the full amount of interest you’ve already earned, plus $625 in emergency savings. Yeah. ah.
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Please note that most banks do not allow partial withdrawals either. So even if you only need $5,000 of your $50,000, you’ll need to withdraw the entire amount to access that amount. This inflexibility makes CDs one of the worst places to store your emergency savings, right next to stocks and other equity investments.
What about CDs without penalties?
Unlike traditional CDs, penalty-free CDs don’t incur penalties for early withdrawals. CD providers typically have a short no-withdrawal period, usually between 7 and 30 days, after which you can access your money without penalty.
These CDs typically offer lower APYs in exchange for penalty-free withdrawals. However, in today’s high rate environment, you can still find many penalty-free CDs with rates over 5%. In fact, penalty-free CDs often rank high in APY on financial platform Raisin, with some currently reaching 5.40%.
Given that there are no penalties for early withdrawals, penalty-free CDs can be a good place to store your emergency funds. Please note that there will be some time lag between canceling the contract and transferring the money to your bank account. However, you won’t have to pay any penalties and may earn higher interest in the meantime.
Should I open a CD for my emergency fund?
Overall, emergency savings are meant to be accessible, which makes traditional CD storage locations risky. Penalty-free CDs can be a way to get the best of both worlds. This gives you easy access to your money and guaranteed interest, but not all banks offer these and when they do, they may have limited terms. It’s certainly a good option, but before you take the plunge, consider comparing it to traditional emergency fund locations, such as a high-yield savings account.
These savings accounts are FDIC insured and can earn 11 times more than banks
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