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I am looking at one of the "internet banks" and they have CDs for 1 year at 1% and 5 years at 2%. The early withdrawal fee for 5 year CD is 150 days of interest. Doesn't it mean that 300 days the CD's break even? In other words if I cancel my CD after at 300 days I'd pay 2% of interest I got in the last 150 days which would be the same as getting 1% for 300 days?

In that case wouldn't one always prefer to buy 5 year CD with current rates if you plan to keep it there at least 1 year?

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    In the US, Federal law requires a minimum penalty of one week's interest for premature withdrawal from a CD, but banks are free to charge more. Thus, your 1 year CD also is likely to have penalties (possibly – Dilip Sarwate Nov 10 '14 at 14:48
  • I understand that. But if you wanted to invest money for 1 year, why (as of today) would you buy 1 year CD at 1% when you are better off with 5 year CD at 2% and with 150 days penalty? – Vitalik Nov 10 '14 at 16:17
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When the yields are significantly different, then as you say, it does make sense to sign up for longer-term CDs. One of the reasons that banks are giving incentives to longer-term CDs is that CD balances have been declining over the last few years (from $2.82T in 2008 to $1.64T at the end of 2013). Yes, you can withdraw early and get a higher rate, indeed some advisers are recommending exactly the strategy you describe. So, yes, most investors would always prefer a longer term CD with the current spreads. Just keep in mind that hasn't always been the case historically and is reasonably likely to change in the future.

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