What Is a Callable Certificate of Deposit (CD)?

A callable certificate of deposit (CD) is a certificate of deposit that gives the issuer the right to "call" or redeem the CD before its maturity date. Banks typically call them when interest rates move lower, allowing the issuing bank to stop paying CD holders more than the prevailing rates. The trade-off for that risk is the higher interest rate than regular CDs.

Callable CDs, like traditional ones, are deposit accounts that offer a fixed interest rate over a predetermined period, typically ranging from several♔ months to a few years. Once you open a traditional CD, you cannot access your deposit or earnings until the maturity date without incurring penalties, a🦋nd the same principle applies to callable CDs.

If your CD is called, you will miss out on future interest returns you would have received had the CD reached its full term, but you do get the interest your account has accrued up to that point, along with the entire initial deposit.

Understanding a Callable CD

Callable CDs typically have longer terms and can't usually be called until after a certain period, known as the "call protection period." If interest rates fall after the CD is issued, the bank might call for the CD to be reissued at a lower rate, which can disadvantage investors looking for long-term, fixed-rate investments. However, the higher initial interest rate can make callable CDs attractive to investors who believe interest rates will remain stable or rise during the call protection period. If redeemed, the bank may reissue new CDs with lower interest rates.

Investors buy them to earn interest for a fixed period while earning more than typical savings accounts. These financial products pay interest until they mature, and the balance is returned to the investor. Should you need the funds earlier than the maturity date, there's usually an early withdrawal penalty.

CDs are a low risk investments, insured up to $250,000 by the FDIC or National Credit Union Administration.

Callable CDs Advantages and Disadvantages

Callable certificates of deposit (CDs) offer higher interest rates than traditional CDs. However, this comes with additional risks. One is the possibility of missing out on higher interest rates if you're locked into a long-term CD when rates rise.

For this reason, it's crucial to understand the difference between a CD's call period and maturity date. For instance, if you're offered a "federally insured five-year non-callable" CD, this doesn't mean it matures in one year. It's just when the issuer can't redeem it. The maturity date may be much further, perhaps 10 or 20 years. Here, we've set out th🧸e advantages and disadvan༒tages of callable CDs:

Pulling the above together and using the technical terms you might see, the call premium is the extra amount over the CD's par value (how much you deposited into the CD initially) that compensates you for the risk of the CD being called before maturity. This premium typically decreases as the CD approaches its maturity date, as reflected in its yield. The specific terms of the call premium are given in the disc🍨losure statement provided before you buy a CD.

Example of a Callable CD

If a bank issues a traditional CD that pays 4.5%, and interest rates fall to a point where the bank could issue the same CD to someone else for only 3.5%, the bank would be paying a 1% higher rate for the duratﷺion of the CD. By using a callable CD, the bank can refinance it and reissue a new CD at a 3.5% yield.

If the bank issued the callable 4.5% CD to mature in two years but set its first call date six months from the date it was issued, it can't retire its CD until after those six months. This lockout period guarantees investors that 4.5% interest will be paid for at least half a year.

Explain Like I'm Five

A certificate of deposit is a bank deposit that pays interest for a fixed period of time. CDs usually pay higher interest than a normal savings account, but the catch is that you can't take your money out until the certificate matures.

A callable CD is just like a regular CD, with a twist. While you can't take your money out early, the bank can decide to return your money early and close the CD. You still keep whatever interest you already collected, but the bank doesn't have to keep paying you interest. These accounts usually pay a higher interest rate, to compensate for the possibility of early redemption.

The Bottom Line

A callable CD offers a higher interest rate than a traditional CD, but with the condition that the issuing bank has the right to "call" or redeem the CD before its maturity date. Before you invest, you should compare the rates of the two products. Then, determine which direction you think interest rates may be headed in the future.