August 15, 2023 • By Trina Paul
When interest rates are high, you can park your money in a certificate of deposit (CD) or high-yield savings account to earn more money. With CDs, you tie up your money for a fixed amount of time in exchange for regular interest payments that you cash out at the end of the CD’s term.
What is a callable CD?
A callable CD is a type of CD that allows banks to terminate a CD before it reaches maturity.
When you open a CD, you deposit a set amount of money for a fixed period of time, which typically ranges from three months to ten years. In return, you’ll earn a fixed APY (unless you have a variable rate CD), with interest compounding on a daily, monthly, or semi-annual basis.
Callable CDs work similarly although there’s one key difference: they carry a call feature, which means banks can terminate a CD before it matures. Banks usually have to wait a period of time before they’re able to call back a CD.
If a bank does call your CD, you get to keep the principal (or the amount you initially invested) and the interest payments you’ve accrued up until it was called. After the CD is called, you won’t get the interest you would have earned had the CD reached maturity.
So why might a bank choose to ‘call’ a CD? Callable CDs are typically ‘called’ when interest rates drop. Let’s say that a bank offers a 3-year CD with a 5% APY. However, one year later, the APY on 3-Year CDs drops to 3%. The bank might ‘call’ your CD because it can issue new CDs with a lower interest rate—which means that you’ll have to reinvest your money somewhere else. Callable CDs offer higher APYs than traditional CDs because of this risk.
You might opt to buy a callable CD if you think interest rates will increase or stay steady in the future, but investors might find it challenging to predict how rates will change in the future.
“It’s very difficult to gauge where rates will be at any point of time from now,” says Scott Sturgeon, founder of Oread Wealth Partners. “People who try to predict this stuff are often incorrect…There are other low-risk assets you can utilize that might be a better fit.”
What is a brokered callable CD?
CDs sold by brokerages are known as brokered CDs. They work like this: Banks issue CDs in bulk and brokerage firms buy those CDs in order to sell them to customers. Some brokered CDs have a call feature, so the bank that initially issued the CD can redeem it before it reaches maturity.
“Since they [brokered CDs] are purchased in a brokerage account, you could have an original issue—where you’re buying it when it is issued—or you could be buying it on a secondary market,” says Peter Salkins, Financial Planner at Integrated Partners.