Like traditional CDs, callable CDs are time deposits that pay a fixed interest rate over a specified term. What differentiates a callable CD from a regular CD is the call option, which means that the bank that issued your CD has the option to redeem, or "call," your CD before the maturity date.
What is a call option? Lets say, for example, that you have a five year CD with a one year call date. What this means is that, one year after you buy the CD, your bank can decide whether it wants to cancel the agreement and return your money, along with whatever interest it has earned up to that point. Its important to understand that, while the bank has this option to dissolve the contract on the call date, you do not have the same option. You are still bound by the maturity date on the CD in this case, five years.
Why would a bank want to call a CD? The main reason a bank or broker will recall a CD is due to a change in the prevailing interest rate. Basically, when you purchase a CD, whats happening from the banks point of view is that the bank is borrowing the money in your CD from you, and paying you a certain interest rate for the privilege of using your money for a certain period of time. If interest rates decline, the bank may be able to borrow money from another source at a lower rate than it is paying you for the CD. At that point, it makes sense to them to say, heres your money back with interest, thanks very much.
If this happens, you will be stuck trying to find a new investment vehicle for your money. However, since callable CDs tend to promise higher returns than regular CDs, if you are looking for a high yield certificate of deposit, it might be worth it to you to take on the risk of reinvestments in order to take advantage of high returns in the short run.
Callable CDs shift the risk of rising and falling interest rates to you, the consumer. Because youre the one taking on the risk, you will get the best CD rates from the bank, but if you have concerns about reinvestment and dont want to watch interest rates, you might be better off getting a traditional CD without a call feature. Be sure to read the fine print and understand what your bank or broker is selling you the investor. Dont be caught off-guard by call features in your search for the best certificate of deposit rates.