Discover Bank Will Increase CD Early Withdrawal Penalties

Discover Bank has issued a new deposit account agreement which describes a new early withdrawal penalty for its long-term CDs. It's important to note that it won't affect existing CDs. The new EWP will only be for new CDs opened, and existing CDs renewed, on or after 3/15/13. Here's a summary of how the EWP will be increased:

• 4- and 5-year CDs: EWP increases from 6mo to 9mo of interest
• 7- and 10-year CDs: EWP increases from 9mo to 15mo of interest

You can read the full EWP details in section 36 of the Discover deposit account agreement. Below is an excerpt:

Early Withdrawal Fees (for CDs opened or renewed through 3/14/13)
For early withdrawal on Certificates of Deposit:

• With a term of less than one (1) year, we will deduct three (3) months’ simple interest on the Issue Amount withdrawn.
• With a term of one (1) year up to and including five (5) years, we will deduct six (6) months’ simple interest on the Issue Amount withdrawn.
• With a term greater than five (5) years, we will deduct nine (9) months’ simple interest on the Issue Amount withdrawn.

In some cases, the Early Withdrawal Fee may reduce the principal in the CD.

Early Withdrawal Fees (for new CDs opened, and existing CDs renewed, on or after 3/15/13 only)
For early withdrawal on Certificates of Deposit:

• With a term of less than one (1) year, we will deduct three (3) months’ simple interest on the Issue Amount withdrawn.
• With a term of one (1) year, but less than four (4) years, we will deduct six (6) months’ simple interest on the Issue Amount withdrawn.
• With a term of four (4) years, but less than seven (7) years, we will deduct nine (9) months’ simple interest on the Issue Amount withdrawn.
• With a term of seven (7) years or greater, we will deduct 15 months’ simple interest on the Issue Amount withdrawn.

In some cases, the Early Withdrawal Fee may reduce the principal in the CD.

Thanks to DA member primary for posting on this news in this forum thread.

My Take

Even though I'm disappointed in seeing the larger EWP, I'm glad Discover Bank did the honorable thing by not affecting existing CDs. We all know the two credit unions that raised the EWP on new and existing CDs. Of course, this doesn't guarantee that Discover Bank will remain honorable in the future. There's also the risk that they could refuse an early withdrawal sometime in the future. I don't know the risk of these possibilities, but the current action reduces my worries.

It should also be noted that you still have time to open Discover CDs with the existing early withdrawal penalties.

Impact to Discover CDs

It looks like Discover Bank realized that its long-term CDs were too good of a deal when compared with other banks. Discover Bank's old small early withdrawal penalty allowed the 10-year CD to be a better deal than Discover Bank's shorter-term CDs even when the 10-year CD is closed early. To see this, I've included the table showing the effective yields of Discover Bank's 10-year and 5-year CDs with today's APYs. The effective yields factor in the early withdrawal penalty. For example, if you close an existing 5-year CD after one year, you'll lose 6 months of interest. That's half of the interest, so the effective yield is half of the CD APY.

With the existing early withdrawal penalty, the 10-year CD will have an effective yield of 1.70% if it's closed at year 5. That's higher than the 5-year CD yield (1.65%). Even if the 10-year CD is closed at year 2, the effective yield is still a respectable 1.25% which is higher than Discover Bank's 2-year CD yield (1.10%).

With the new early withdrawal penalty, the 10-year CD won't be nearly as good of a deal when closed early. In all cases, you'll do better with a shorter-term CD rather than the 10-year CD closed early. However, as the time to closure lengthens, the early withdrawal penalty has less impact. For example, at year 2, the effective yield is 35 bps lower than the 2-year CD APY (0.75% vs 1.10%). At year 5, the effective yield is just 15 bps lower than the 5-year CD APY (1.50% vs 1.65%).

The early-withdrawal yields listed below are based on the spreadsheet developed by Bogleheads forum members. It's available from the Bogleheads Wiki: Comparing CDs. It should be noted that the following simple formula comes very close to this spreadsheet:

Post Penalty APY = (Full APY) x (D - P) / D

D = days into term when the CD was closed.
P = days of the early withdrawal penalty

If you want an easy way to calculate the effective interest rates on your own, a reader developed this useful online calculator. It can calculate the effective interest rate for any month that a CD is closed before maturity.

These CD APYs are based on the yields listed at the Discover Bank's website as of 2/20/2013: