The Federal Reserve implemented a series of interest rate hikes in 2022 and 2023 in an effort to slow inflation down. And the central bank’s efforts have worked to some extent. Although living costs are still up, the pace at which they’re rising isn’t as extreme as it was back in 2022.
Unfortunately, the Fed’s numerous rate hikes have made it more expensive for consumers to borrow money, whether in loan or credit card form. But on the plus side, savings accounts and certificates of deposit (CDs) are now paying more generously following those rate hikes.
It’s an especially appealing time to put money into a CD, with rates being at or above 5% for many of these products. But while today’s CD rates might inspire you to put all of your cash into a CD, that’s a move you might sorely regret.
Don’t risk an expensive penalty
Today’s CD rates aren’t going to stick around forever. Once the Fed starts lowering rates, which is expected to happen later this year, CDs are bound to start paying less. Because of this, you may be inclined to put all of your money into a CD while rates are high. But doing so could backfire on you in a very serious way.
When you cash out a CD before its maturity date arrives, you generally face a costly penalty, the exact amount of which will depend on the bank you use and the term length of your CD. For example, the penalty for cashing out a CD with a term of 12 months or less could be three months of interest, regardless of when you redeem the CD prior to maturity.
So let’s say you open a $5,000, 12-month CD at 5%. If you cash it out before the one-year mark, you’re looking at a penalty of $62.50. And while you could argue that that’s not a catastrophic amount of money to lose, imagine if you decide to open that same CD with $25,000. In that case, you’re looking at a penalty of $312.50 for an early cash-out. So it’s important to be careful either way.
Make sure to leave yourself ample funds for emergency savings
Tempting as it may be to throw all of your money into a CD right now, you never know when you might need the cash to cover an unplanned expense. So it’s important to keep some money in a regular savings account for emergency fund purposes.
Specifically, keep at least enough cash to cover three full months of essential bills. And if you have other potential expenses on your radar, add to that three-month total to cover those, too. For example, if you’ve been told you’ll need to replace a certain car part in the near future at a cost of $800, keep enough cash on hand for three months of essential expenses plus the $800 needed to make sure your car can run.
Capitalizing on today’s CD rates makes a lot of sense. But it doesn’t make sense to tie up all of your money in a CD and risk having to pay an expensive penalty as a result.
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