Are Callable CDs Worth It?

A callable CD is a certificate of deposit that an issuer can “call back” from an investor after the expiration of a “call-protection” period, but before the CD matures. Such an investment can look appealing because it can offer a higher initial yield during the protection period, but can be risky during the time the issuer can call it back. Essentially, the risk of fluctuating interest rates is shifted to the consumer.

Here’s an example: You buy a “callable” CD that will mature in five years. Since it is paying 3% interest  – a good point higher than similar non-callable CDs – you decide to take the risks. What are the risks? Say this particular CD has a call protection period of six months. During the six months, your CD is earning an annual return of 3%. At the same time, interest rates drop a point, meaning that not only are you getting a full point more than you would with a regular CD, but you’re getting another point more than you would if you were to buy at the new, lower rate of interest.

Therein lies the downside: Once your six months are up, the issuer (usually a bank) has the right to “call back” your CD, pay you your interest, and go borrow their money from someone else at the new, lower rate. Even if the interest rates do not fall during that first six-month period, depending on the agreement, the bank will be able to do this every six months up until maturity.  Then you presumably have to take your money and park it in a CD that is now offering a much lower rate — say, 1% for a non-callable CD. Had you chosen that type of product from the start, you’d have fixed your rate of return at 2% for the duration of the five-year term.  If instead the interest rate (or yield) goes up a point during the call-protection period, you are still locked into the 3% yield and cannot pull your money out to buy a higher-yielding CD without incurring penalties.

There can be upsides, of course, but it depends on your stomach for risk, and your willingness to keep shopping for products perhaps every six months. For instance, if  interest (or yield) rates dropped from 2% to 1% the first day after you bought your 3% callable CD,  you’d have a full six months of a very favorable spread. In the end, though, you can bank on the issuer calling that back. If you’re not keen on studying trends in interest rates, and prefer simplicity, callable CDs are probably not for you.

As with any investment, make sure you read the fine print, and consult with an advisor over something as complicated as a callable CD.