The early withdrawal penalty is a fixed cost and the higher rate is a monthly gain, so the answer depends on how long the old CD has left to run.
Breaking a CD early is worth it only if the balance left after the penalty, grown at the new rate, ends above what the old CD would have paid over the same months. In an illustrative case, 10,000 in a 2.50 per cent CD with 30 months left and a 12-month interest penalty ends at 10,636.77 if kept and 10,884.17 if broken and reinvested at 4.50 per cent: 247.40 ahead, with a break-even new rate of 3.54 per cent. With less than 15.7 months left, the same switch loses money.
Worked in full in Personal Finance for Beginners by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The question comes up whenever deposit rates rise after money has been locked in. A two-point higher rate looks decisive, and the penalty looks small next to the balance. Neither impression is a calculation. The penalty is a cost paid once, today; the higher rate is a gain earned month by month, only for as long as the old CD would have run. So the answer depends mostly on the months remaining. This is a worked example of the arithmetic, not a recommendation: the inputs that matter are on your own CD agreement.
| Input | Value |
|---|---|
| Current CD balance | 10,000 |
| Old CD rate (APY) | 2.50% |
| Months left to maturity | 30 |
| Early withdrawal penalty | 12 months of interest |
| New CD rate (APY), same 30 months | 4.50% |
The penalty is taken as twelve months of simple interest on the amount withdrawn at the old CD's rate, a common way banks state it. Some banks use more or fewer months, or compute it differently, so read the agreement before running the numbers. Both CDs are compared over the same 30 months, which is the only fair comparison.
Penalty = balance × old rate × penalty months ÷ 12
10,000 × 2.50% × 12 ÷ 12 = 250.00, or 2.50 per cent of the balance. The amount that can be moved is 9,750.00. In Excel: =B1*B2*B4/12.
Keep = balance × (1 + old APY)months/12
Break = (balance − penalty) × (1 + new APY)months/12
Keep: 10,000 × 1.0252.5 = 10,636.77. Break: 9,750 × 1.0452.5 = 10,884.17. In Excel: =B1*(1+B2)^(B3/12) and =(B1-B6)*(1+B5)^(B3/12).
| Route | Starting amount | Interest earned | Ending balance |
|---|---|---|---|
| Keep the old CD | 10,000.00 | 636.77 | 10,636.77 |
| Break and reinvest | 9,750.00 | 1,134.17 | 10,884.17 |
| Difference | 247.40 |
After the penalty, the new CD's net interest is 884.17 against 636.77. Breaking wins by 247.40 here.
Two numbers tell you how much room there is. The break-even new rate is the rate at which 9,750.00 grows to 10,636.77 in 30 months:
Break-even rate = (keep balance ÷ amount after penalty)12/months − 1
(10,636.77 ÷ 9,750.00)12/30 − 1 = 3.54 per cent, 1.04 points above the old rate. Any new rate above that wins; the offer at 4.50 per cent clears it comfortably.
The break-even remaining term holds the two rates fixed and asks how many months the higher rate needs to earn back the penalty. Here it is 15.7 months. With more time left, switching wins; with less, keeping the old CD to maturity comes out ahead.
| Months left | 3-month penalty | 6-month penalty | 12-month penalty | 18-month penalty |
|---|---|---|---|---|
| 6 | 34.41 | -29.49 | -157.27 | -285.05 |
| 12 | 134.69 | 69.38 | -61.25 | -191.88 |
| 18 | 238.44 | 171.67 | 38.14 | -95.39 |
| 24 | 345.75 | 277.50 | 140.99 | 4.49 |
| 30 | 456.71 | 386.94 | 247.40 | 107.86 |
| 36 | 571.43 | 500.11 | 357.46 | 214.82 |
The pattern is regular. Each month of penalty costs about 20.83 on this balance, and each month of the two-point rate gap earns back roughly 16.67 before compounding. A rule that fits most cases: switching pays when the months left are clearly more than the penalty months multiplied by the old rate and divided by the gap between the rates. Here that is 12 × 2.50 ÷ 2.00 = 15 months, close to the exact 15.7. At 30 months left the break-even new rate is 2.76 per cent with a 3-month penalty, 3.02 per cent with 6 months and 4.08 per cent with 18 months.
A penalty can exceed the interest earned. Four months into a new 10,000 CD at 2.50 per cent, the CD has earned 82.65, while a 12-month penalty is 250.00. Withdrawing then returns 167.35 less than was deposited. Banks are generally allowed to take the penalty from principal, so the agreement matters most early in the term.
The tempting comparison is the old CD's remaining 30 months against a new 60-month CD at 4.50 per cent. Broken into a five-year CD, the 9,750.00 grows to 12,150.27 at the end of year five. Keeping the old CD and then rolling 10,636.77 into a new CD at, say, 3.50 per cent for the last 30 months reaches 11,592.06. The 558.22 difference looks like the gain from breaking, but most of it is a bet that rates will fall: if they are above 5.47 per cent when the old CD matures, the keep-and-roll route catches up. Only the same-horizon comparison measures what breaking the CD is worth; the longer term is a separate decision about locking in a rate.
The other mistake is to compare the rates alone. Two points on 10,000 is 200.00 a year, or 500.00 over 30 months, which makes the switch look twice as good as it is. The penalty, and the slightly smaller amount earning the new rate, take it to 247.40. The difference between a quoted rate and what an account actually pays is set out in APR vs APY, and the same reasoning about staggered maturities is behind a bond ladder.
Work out the penalty in money, grow what is left at the new rate over the old CD's remaining months, and compare ending balances: 10,884.17 against 10,636.77 here. Then check the two break-evens, 3.54 per cent and 15.7 months, to see how much margin there is. Personal Finance for Beginners covers saving and borrowing from the ground up, and the free workbook for the book applies the same month-by-month approach to paying off debt.
Most banks state it as a number of months of interest on the amount withdrawn, at the CD's own rate. On an illustrative 10,000 CD at 2.50 per cent, a 12-month penalty is 10,000 times 2.50 per cent, or 250.00, and a 6-month penalty is half that. The exact rule, including whether it uses simple interest, is in the account agreement, and it differs from bank to bank.
Yes, if the CD has not yet earned as much interest as the penalty. Four months into an illustrative 10,000 CD at 2.50 per cent, accrued interest is 82.65 while a 12-month penalty is 250.00, so withdrawing returns 167.35 less than was deposited. Early in the term a penalty is usually larger than the interest earned.
The rate at which the balance left after the penalty grows to the old CD's ending balance over the same months. With 30 months left on an illustrative 2.50 per cent CD and a 12-month penalty, that is 3.54 per cent, about 1.04 points above the old rate. With a 6-month penalty it falls to 3.02 per cent.
This article is one calculation from Personal Finance for Beginners. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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