Callable CDs are an alternative to traditional CDs that typically come with higher interest rates. But callable CDs also come with more risk than other CDs. The key difference between the two is that, with a callable CD, the CD issuer can “call back” or redeem the certificate of deposit before the CD matures. This is typically to protect the issuer from paying higher interest rates to investors when interest rates drop.
There are a lot of different certificates of deposit on the market — traditional CDs, add-on CDs, bump-up CDs, and callable CDs, to name a few. It can be difficult to know which one to pick, but a lot of it depends on how the economy is going, the state of the market, and your personal finance goals.
Today we’re going to take a closer look at callable CDs, why some CDs come with a callable feature, the pros and cons, and whether this type of savings or investment product is the right fit for you.
What is a callable CD?
A traditional CD, also known as a time deposit, requires you to place your money into an account that comes with a fixed interest rate and a maturity date. After the CD’s maturity date, you get your initial investment back plus interest. And, common with almost any type of CD, if you choose to liquidate your CD early, prior to maturity, you will be subject to an early withdrawal penalty.
A callable certificate of deposit, by contrast, has essentially the same features as a regular CD, except the financial institution that issued the CD has placed a call option (or call provision) on the security. This means that at any time after the callable date, the issuing bank has the right to redeem the CD in exchange for the initial deposit plus any interest earnings accrued up until that point.
In this scenario, an investor doesn’t lose any money in the deal, but neither do they get the full value of the financial product they invested in. If a cd is “called” the investor will have to find an alternative way to invest that money.
If you prefer to have your money gain the maximum interest possible, you may want to look into a traditional CD instead. Start by comparing your options below.
Why do banks issue callable CDs?
A bank or brokerage firm might choose to issue callable CDs so that they don’t get stuck paying higher interest for the entire term of the certificate of deposit if interest rates drop.
With a traditional CD, your interest rate is locked in for the whole term. For example, if banks or credit unions issue three-year regular CDs at 5%, but after a year interest rates rise or fall, that financial institution is still on the hook for the full 5%.
On the other hand, if banks offer CDs with a call option, and interest rates fall, the bank can call the CD (buy it back). Continuing with the above example, a three-year callable CD at 5% where the interest rate drops to, say, 3% after one year, can be redeemed by the bank, thereby saving itself 2% in interest for the next two years.
Why buy callable CDs?
So why would you buy a callable CD if the bank or brokerage firm can just take it right back from you? There are a few reasons why you might be willing to take on the higher risk of a callable CD over a regular CD.
For one thing, interest rates for callable CDs are typically higher than with regular CDs. A higher interest rate means bigger returns for the investor, and there’s always the chance that the call feature will never be exercised.
For example, if CD rates rise, there would be no incentive for the CD issuer to redeem it because you’re getting lower than the going rate. The issuer will typically only call the CD if it’s going to save them money. Of course, if you choose to cash out your funds early, you’ll have to pay the bank an early withdrawal penalty, so you may be stuck with the CD until the maturity date.
Another incentive to take a chance on a bigger payout with a callable CD is the call protection feature. The call protection period is the amount of time when the issuing bank is not allowed to call back your CD for any reason. Instead, it must wait until the callable date to execute the call feature.
The protection period varies but could be only months with a short-term CD. For example, if you have a one-year callable CD that you purchased on June 1 with a protection period of six months, the callable date is December 1. Prior to that, your CD is “safe.” After the December 1 call date, the issuing bank can execute the call provision at any time. Which, as mentioned, would probably only happen if interest rates go down.
It should be noted that sometimes callable securities also come with a call premium, which is an additional financial incentive to encourage individuals to invest. A call premium is more common with a callable bond rather than a CD, but it is possible.
Example of a callable CD
Say you put $10,000 into a one-year callable CD at a 4% interest rate. After six months, CD interest rates fall, so your issuing bank or brokerage firm calls back the CD. On the upside, you get your full investment back plus some interest.
On the other hand, if you choose to reinvest your money into a more stable new CD with a 3% interest rate, you lose out on all the interest at the higher rate you would have gotten had the call feature not been executed.
Callable CDs pros and cons
As with any financial decision, it’s important to weigh the risks and rewards of callable CDs before embarking on this investment.
Here is a list of the benefits and drawbacks to consider.
- Callable CDs usually have more competitive rates than traditional CDs.
- You’ll earn interest at a higher rate during the call protection period.
- Even after the call date, the CD issuer may never execute the call provision.
- Whether the CD is called or not, it’s protected by federal insurance.
- Because of the call provision, the CD term is not assured.
- The interest is not a guaranteed rate if your CD is redeemed early.
- An early withdrawal fee is required if you redeem the funds early.
- You may have to buy a new CD — at likely a lower rate — or find a new investment product if your CD is called back.
Can you lose money on callable CDs?
The nice thing about CDs in general is that they’re very safe (although not terribly lucrative) investments. You may not make a ton of money in interest, but you’ll always get your money back plus a little extra income.
That’s because deposit accounts, like most CDs and your regular checking and savings accounts, are federally insured. If your money is with a bank, it’s insured by the Federal Deposit Insurance Corporation (FDIC). When you go through credit unions, your money is insured by the National Credit Union Administration (NCUA). Both NCUA and FDIC insurance protect each cash account up to $250,000.
- A callable CD means a bank can redeem your CD early prior to its maturity date but after the call protection period.
- The callable date for the CD can be months or even years after you’ve bought the callable CD but before its maturity date.
- Financial institutions will typically give a higher interest rate for callable CDs than for traditional CDs.
- Because most callable CDs are FDIC-insured, the only real risk is that the bank will call your CD prior to its maturity date.
View Article Sources
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- What is a certificate of deposit (CD)? — Consumer Financial Protection Bureau
- Investments in Brokered Certificates of Deposits — National Credit Union Administration
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- Publication 550 | Investment Income and Expenses — IRS
- What is a Certificate of Deposit (CD)? — SuperMoney
- How to Use a Real Estate Certificate of Deposit to Buy Property — SuperMoney
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- Barclays CD — SuperMoney
- CIT Bank Term CD — SuperMoney
- Bank of America Standard Term CD — SuperMoney
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- US Bank CD — SuperMoney