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Certificate of deposit accounts lock in your money for a certain period and guarantee an interest rate. But sometimes, life happens in the middle of the CD’s term. You have a dental emergency, your car needs new tires, or (yes, please!) a friend offers you a once-in-a-lifetime opportunity to join a trip to Barcelona but you just don’t have cash on hand to afford it. In these and other situations, you may be tempted to crack into a CD.

Should you do so, however, you will likely have to pay an early withdrawal penalty since you aren’t sticking with the agreed-to maturity term (the amount of time the CD was set for). You might forfeit some or all of the interest earned as a result. Read on to learn more about early withdrawal penalties for CDs and how to avoid them.

What Is a CD Early Withdrawal Penalty?

First, what is a CD? In simple terms, it’s an FDIC-insured time deposit. When you open a certificate of deposit account, you’re depositing money for a specific time frame. Depending on the CD, this may be as little as 30 days or as long as 10 years.

As the CD matures, your balance can earn interest. Generally, the longer the term, the higher the interest rate and APY. However, if you take money out before the maturity date, the bank can charge a CD withdrawal penalty.

Federal law sets the minimum penalty for early CD withdrawal at seven days’ interest if you withdraw money within the first six days after deposit. Banks can set the maximum CD withdrawal penalty higher.

The amount you might pay for withdrawing money from a CD early can depend on several factors, including:

•   Maturity term of the CD

•   How long the CD was open before you made the withdrawal

•   The amount of the initial deposit and the amount that’s withdrawn.

Your bank may or may not allow you to make a partial early CD withdrawal. If you’re not able to withdraw a partial amount, you might have to cash out the whole CD which could result in a larger penalty.

How to Calculate an Early Withdrawal Penalty for a CD

You’re probably wondering just how steep a penalty you’d have to pay for early CD withdrawal. Are we talking $5 or 5% of the money invested? More?

Banks are required to provide you with certain disclosures regarding your accounts, including CD accounts. So the first step in calculating what you might pay for a CD early withdrawal penalty is to review your bank’s policy.

Again, this can vary depending on the bank. So, for example, here’s what a few banks charge if you make an early withdrawal from CD accounts. All penalties are deducted from the CD’s principal.

You should be able to find this information readily available on your bank’s website. But if not, you can contact your bank or visit a branch to get more details on the penalties for early withdrawal from a CD. In addition to telling you what the penalty is, the bank should also be able to tell you how the penalty is calculated.

Banks may calculate the penalty for early CD withdrawal based on:

•   The amount withdrawn

•   The entire balance

•   Daily interest or monthly interest.

Calculating a CD Early WIthdrawal Penalty

Want to get a little more granular? Let’s dive into a little basic math to show you how the numbers look. Using Chase as an example, we see that the bank uses the amount withdrawn as the basis for calculating CD early withdrawal penalties. The calculation uses daily rather than monthly interest.

So the formula for calculating the penalty you might pay for an early CD withdrawal would look like this:

Penalty = Amount withdrawn x (Interest rate/365) x number of days’ interest.

So, say you have a 12-month CD that’s earning a 5% APY. You withdraw your initial $5,000 deposit six months prior to the CD’s maturity date. The math would look like this:

$5,000 x (0.05/365) x 180 = $123.29

You could also use an online CD early-withdrawal penalty calculator to figure out how much interest you might forfeit if you decide to withdraw money from a CD ahead of schedule.

Ways to Avoid Early Withdrawal Penalties for a CD

There are some options for avoiding prepayment penalties associated with early CD withdrawals. The strategies you could try include:

•   Withdrawing only the interest earned. Your bank may allow you to withdraw the interest earned on a CD without assessing a penalty. This assumes that you don’t touch the principal amount at all. This could be an attractive option if you need some quick cash but don’t necessarily need or want to withdraw your initial deposit.

•   Requesting a waiver of the penalty due to a crisis. If you are really in a bind, your bank may honor this.

•   Tapping your rainy-day money instead, but this should really only be done if you have the right reason to using your emergency fund.

•   Opening a no-penalty CD account. Banks can offer CDs that don’t charge a penalty for early CD withdrawal. The trade-off is that no-penalty CDs may offer a lower interest rate and APY, so you’d have to consider whether the convenience afforded by no-penalty CDs outweighs earning a higher rate.

•   Building a CD ladder. A CD ladder is a collection of CD accounts, each with varying maturity terms. So you might have five CDs with maturity dates spaced six months apart. The idea is that you can avoid early withdrawal penalties because your next maturity date is always on the horizon.

•   Consider a CD-secured loan. You may find some lenders who offer a CD-secured loan, but review the terms carefully and be sure you can make the payments at a time when money is tight.

Recommended: What Does Private Banking Offer?

When to Withdraw CDs Early

Withdrawing money from a CD early, even if it means triggering an early CD withdrawal penalty, could make sense in some situations. Some examples:

•   If you have an emergency situation with no other cash reserves to rely on and you want to avoid using credit, it may be the best (or only move). For example, say your car breaks down and you need $5,000 to fix it, but you only have $1,200 in your emergency fund. Then paying a CD withdrawal penalty could be worth it. This move would allow you to avoid having to charge the expense on a high-interest credit card or take out a loan.

•   Paying a penalty for early CD withdrawal could be worthwhile if your interest rate is low. You could access the funds and, with what you don’t use up, roll the money into a new CD with a higher APY. You’d have to calculate the amount of the penalty for withdrawing money early and compare that to the interest you could earn with a new CD to decide if it’s worth it or not.

Recommended: 10 Personal Finance Basics

The Takeaway

Investing in CDs can make sense if you want a safe way to earn interest on money you don’t necessarily need for the near-term. But sometimes, you’ll feel you must withdraw money early from a CD, despite the fact that you locked in for a specific term and interest rate. When doing so, you’ll face penalties, which may or may not make this transaction worth it to you. You can also follow a couple of smart money strategies to make sure you avoid triggering early CD withdrawal penalties in the future, because who wants to pay fees unless you absolutely have to?

If you hate penalties and fees, it can be wise to consider all your possibilities in terms of where to keep your money.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

FAQ

What happens if I take money out of a CD early?

If you withdraw money from a CD early, you will likely be assessed a penalty, which is often all or some of the interest earned, and possibly a fee.

Can I write off a CD early withdrawal penalty?

If you wind up paying an early withdrawal penalty, you can deduct the amount from your taxes, even if it’s greater than the interest earned.

About the author

Rebecca Lake

Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.

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Vanilla options are put or call contracts that give traders the right to buy or sell an underlying asset at a predetermined price before a set expiration date. The most basic type of options contracts, vanilla options follow standard contract terms (e.g., fixed expiration dates and strike prices) and are traded on exchanges like the Chicago Board Options Exchange (CBOE). This is in contrast to exotic options which allow for more customization and are generally traded over-the-counter (OTC) through a broker-dealer network.

Vanilla Option Definition

The term “vanilla options” refers to standard contracts in options trading. They come with fixed features, including expiration dates, strike prices, and contract sizes.

What Are Options Contracts?

Buying an option is purchasing a contract that represents the right, though not the obligation, to buy or sell an underlying security at a fixed price (the strike price) by a specified date (the expiration).

•   The options buyer (or holder) has the right, but not the obligation, to buy or sell the underlying asset (e.g. stock shares) at a certain price by the expiration date of the contract. Buyers pay a premium for each option contract; this is the cost of the option.

•   The options seller (or writer), who is on the opposite side of the trade, has the obligation to fulfill the contract terms, such as selling or buying the underlying asset at the agreed-upon price (i.e. strike price) if the options holder exercises their contract.

What Are Exotic Options?

To understand what makes an exotic option exotic, let’s review a traditional vanilla options contract and how it works.

When trading a traditional option, the owner can buy or sell the underlying security for an agreed-upon price, either before or at the option’s expiration date. The holder is not, however, obligated to exercise the option, hence the name.

An exotic option typically has all of those features, but with complex variations in the times when the option can be exercised, as well as in the ways investors calculate the payoff. For those features, they typically charge a higher price than traditional options. Also, unlike standard vanilla options which are traded on an exchange, exotic options are usually traded in over-the-counter (OTC) markets.


💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

What are the Different Types of Vanilla Options?

There are two types of vanilla options: calls and puts.

Calls

A call option allows an investor to buy 100 shares of an underlying stock or other security at the agreed-upon strike price. A call option gives a buyer a way of profiting from a stock’s price increase without having to purchase the underlying 100 shares. The call buyer only pays a premium per share, which is much lower than the price of the stock.

The profit from a call option is determined by both the premium an investor pays and whether they’re able to exercise the option to buy the underlying asset at the lower strike price. (On the opposite side of the trade, the call writer is obligated to sell the buyer the shares if they decide to exercise.)

A call option buyer can also sell the call option for a premium. By selling the option itself, an investor doesn’t have to take delivery of the underlying shares and may profit from the increasing value of the option.

Note: If the price of the stock falls instead of rises, the maximum loss for the buyer is limited to the cost of the premium paid. However, the potential loss for the option writer can be substantial — theoretically unlimited — since the stock price could continue rising with no cap.

Puts

A put option is essentially the inverse of a call option. Instead of giving the buyer the right to purchase an asset at a fixed price, a put allows the buyer to sell an asset at a fixed price before expiration. Investors may buy puts to try to profit from a stock’s decline, or to hedge against losses on stocks they already own.

For example, if a stock’s price declines before the option’s expiration and falls below the strike price, the buyer can exercise the option, selling the stock for a higher price than the market price. Their profit is reduced by the premium paid for the option.

Protective puts involve purchasing a put option while simultaneously holding shares of the underlying stock. This strategy ensures the investor can sell at a predetermined price even if the stock declines, limiting potential losses. If the stock price rises, they still benefit from the gains, minus the cost of the put premium.

Puts do come with risk. If the stock price rises instead of falls, the put option expires worthless and the buyer’s maximum loss is limited to the premium paid. The put writer, however, faces substantial losses if the stock price plummets.

Recommended: Popular Options Trading Terminology to Know

Characteristics of Vanilla Options

Like all investments, purchasing vanilla options carries a level of risk and volatility. Option buyers risk losing the entire premium paid if the option expires worthless. Call writers risk unlimited losses since stock prices could rise indefinitely, while put writers may be forced to buy the asset at the strike price even if the market price is significantly lower.

Premiums

Whether you are interested in buying a vanilla call or put, you will pay a premium in addition to what you would pay to purchase the stock with the call (should you choose to exercise the option). The premium is nonrefundable, so if you don’t exercise the option, you’ve lost what you paid for the premium.

Volatility

The volatility of an option determines its price. Higher volatility generally results in a higher premium because there is more opportunity for a profit (as well as the risk of loss).

Risk Level

Like most other types of investments, buying options are not without risk. If a stock is lower in price on the market than a call option, the option is worthless. And if a stock has a higher price on the market, the put option won’t net more return on investment.

However, a vanilla option may sometimes be less risky than buying a stock outright for buyers, since the only thing you’re guaranteed to spend is premium. For option writers, however, the risk can be significantly higher. A call writer faces potentially unlimited losses if the stock price keeps rising, while a put writer may be forced to buy the asset at the strike price, even if the market value is significantly lower.

Pros and Cons of Vanilla Options Trading

Options trading is complex and involves risks, but for experienced investors who understand the fundamentals, options can be a useful tool for hedging, income, or straight speculation — as long as you know the risks.

Pros

•   Options trading allows investors to put up a smaller amount of money upfront, which can help minimize potential losses. For buyers, the maximum risk is limited to the premium paid for the option.

•   Selling options allows the writers to collect premiums, although there is the risk of significant losses. (Again, when selling a call option, potential losses can be unlimited if the underlying asset’s price continues to rise with no cap.)

•   Some investors offset risk with options. For instance, buying a put option while also owning the underlying stock allows the options holder to lock in a selling price, for a specified period of time, in case the security declines in value, thereby limiting potential losses.

Cons of Options Trading

•   A key risk in trading options is that losses can be outsized relative to the cost of the contract. When an option is exercised, the seller of the option is obligated to buy or sell the underlying asset, even if the market is moving against them.

•   While premium costs are generally low, they can still add up. The cost of options premiums can eat away at an investor’s profits.

•   Because options expire within a specific time window, there is only a short period of time for an investor’s thesis to play out. Securities, like stocks, do not have expiration dates.

Examples of Vanilla Options

If you’re considering vanilla options as part of your options trading strategy, here are a few examples to illustrate how they work for both calls and puts.

Example of a Vanilla Call Option

A call option allows you to purchase a stock at a certain price within a specified time period. Bullish investors who expect a stock to go up in price typically purchase call options.

For our example, let’s say you’re interested in a stock that trades at $53 per share, and you can buy a call option with a strike price of $55 per share. The premium for the option is $0.15 per share, or $15 total for 100 shares of the stock.

Your breakeven point is the strike price plus the premium. In this case, that would be $55.15. If the stock trades above this price, your option is profitable. Let’s say that, after two weeks, the stock is trading at $59 per share. It is now “in the money” because the market price exceeds the strike price.

At this point, you have two choices. You can either exercise the option and buy the shares at $55 per share (and then sell them at the market price of $59 per share), or you can sell the option contract itself based on its intrinsic value (roughly $4 per share or $400 for the contract, less any transaction costs).

Each approach allows you to realize a profit from the rising stock price without owning it outright until you purchase the call option, if you choose to do so.

Example of a Vanilla Put Option

A put can act as a form of insurance, allowing you to protect against losses if the price of the stock you’re holding falls. It’s also one way that investors might short a stock. Here’s an example.

Let’s say you own 100 shares of a stock that is currently trading at $25 per share. You buy a put option at a premium of $1 per share that expires in two months at a strike price of $30. So in total, you paid $100 for a premium for 100 shares.

In a month, the stock price drops to $18 per share. This is a good time to exercise your put option, selling your 100 shares at the strike price of $30 per share, rather than the market price of $18 per share.

The Takeaway

Vanilla options, which are simply standard puts and calls, can be a way to diversify your investment portfolio and potentially hedge against other losses. While investors are not able to sell options on SoFi’s options trading platform at this time, they can buy call and put options to try to benefit from stock movements or manage risk.

SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.

With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.