If you’re aiming to avoid risk while earning a return, you are likely considering certificates of deposit. Traditional CDs offer a guaranteed rate of return, but they come with one requirement: You cannot withdraw your money before it reaches its maturity date without risking a penalty. However, CDs are not all created equal. One type of alternative CD is a callable CD. These typically look more appealing, as they often have above-average interest rates. However, you should read the fine print before you open one.
What is a callable CD?
Callable CDs give the bank or brokerage firm the right to call or redeem a CD earlier than you anticipated. You’re most at risk for having the bank take back the CD early if interest rates suddenly drop. It’s less likely your CD will be called if interest rates go up.
If your CD is redeemed before it reaches maturity, you will still receive your full principal and the interest it has earned up to that point. However, you won’t earn all the interest you initially planned for and will have to reinvest your money somewhere else — potentially at a lower rate.
And the callable feature is only one way: from the issuer. You cannot call the CD early if you need access to the funds without incurring an early withdrawal penalty.
You might have a harder time finding callable CDs at banks because they are less common than traditional CDs.
How callable CDs work
Callable CDs work like most other CDs: You open one at a financial institution or a brokerage firm. You deposit your money and plan to withdraw or renew it when the CD reaches maturity, but the issuer has more flexibility.
You decide to deposit $15,000 in a 4-year callable CD that earns interest at 3 percent. With your earning power, you should have more than $1,882 of earnings at the end of the term. However, after two years, the issuer decides to use its call feature. You’ll get back your principal, plus $913.50 worth of interest earnings, but you’ll need to find another investing option.
Maturity date vs. callable date
If you’re considering a callable CD, it’s important to know how different dates on the calendar can impact your finances. The maturity date is when the certificate of deposit reaches the end. For example, if you open a four-year certificate of deposit on May 1 of 2021, your maturity date will be May 1 of 2025. It’s important to note that callable CDs come in a wide range of terms – as long as 20 years.
Your callable date refers to when your issuer has the right to close out your CD, which is earlier than your maturity date. There is typically a non-call period, which prevents the issuer from calling too early (typically six months to five years, according to Wells Fargo Advisors). Make sure you inquire about the callable date if you’re thinking about opening a callable CD so you have a full understanding of when the issuer can decide that time’s up.
Where to open a callable CD
You can open a callable CD through a bank or brokerage firm, although callable CDs are not advertised at many of the major national banks. If you do find one, make sure that the issuer you choose has a solid reputation for working with customers and that it is insured by the Federal Deposit Insurance Corp.
Since there is always the possibility that you will need to withdraw cash before the CD matures, check to see what kind of early withdrawal fees the issuer charges.
Pros and cons of callable CDs
Like most investments, there are upsides and downsides to callable CDs. Be sure to weigh the following pros and cons before opening a callable CD.
Higher interest rate: One of the biggest benefits of a callable CD is that it typically pays a higher interest rate than what standard CDs offer.
Fixed interest rate: Like traditional CDs, one of the advantages of callable CDs is that you will earn a fixed interest rate over the life of the CD. So if interest rates suddenly drop, you’re locked in at a fixed rate. However, the issuer could redeem the CD early.
Your principal is protected: There are risks with callable CDs, but it’s still a reasonably safe investment. Even if the issuer redeems the CD early, you won’t lose out on your original investment, thanks to FDIC insurance.
Additional complications: The standard benefit of regular CDs is the lack of any work on your part: Invest, watch it earn and withdraw at the end of the term. With callable CDs, you might have to deal with the hassle of finding a different investment sooner than you expected. Plus, if the issuer calls your CD, interest rates have likely declined, which means you’re going to struggle to find similar earning potential. If you have a 10-year CD that is called four years into the term, you’re going to need to figure out how to make up for those earnings for six years.
Potential early withdrawal penalty: Just like traditional CDs, there is some risk if you don’t keep the account open until maturity. If you cash out a CD before it comes due, you will likely have to pay the issuer a penalty fee.
Callable CDs may be a good option for low-risk investors that are looking to earn higher returns on a CD. There is a chance the CD will be redeemed before it reaches maturity, but you won’t risk losing your original investment. You could also explore other alternative CDs with benefits that are in your favor such as a CD that doesn’t charge an early withdrawal penalty or a CD that allows you to request to raise your rate a certain number of times prior to maturity.