A callable CD often pays a higher interest rate than a regular CD, but the bank has the option to “call” or end the CD before it reaches maturity.
Here’s a closer look at how callable CDs work and when you may want to consider one.
Definition and Examples of a Callable CD
A callable CD is a type of certificate of deposit a bank or credit union can “call” before the CD’s maturity date.
Note
When a callable CD is called, you get back your full deposit plus any interest earned up until that point.
Say you open a six-year callable CD with a one-year maturity date. If you hold your CD until maturity, you get 100% of your expected interest. However, if the bank calls your CD at the six-month callable date, you get 50% of the interest you would’ve received at maturity. If it calls at the nine-month mark, you get 75% of the interest.
How Does a Callable CD Work?
A callable CD works just like a regular CD—but it has a call provision that gives the bank the right to terminate it before maturity.
The main reason banks call CDs before maturity is if interest rates drop. When this happens, the bank or broker may feel like it’s paying you too much interest on your account, so it will “call” your CD. They give you your initial deposit back plus interest. The bank or credit union gets the CD’s interest off its books, but you miss out on the full interest you could have earned at maturity.
Note
Callable CDs have somewhat of a double standard: Your bank has the power to change their mind and terminate it without penalty, but you can’t do the same.
For example, a bank may offer a 24-month callable CD with a one-year lock, meaning the bank could call your CD as early as the one-year mark. If the bank chooses not to call the CD, your certificate of deposit would mature in 24 months. This would be the earliest date you could withdraw your money without penalty.
If you’re considering a callable CD, remember the following key terms:
- Maturity date: The earliest date you can withdraw your money without interest
- Callable date: The earliest date your institution can call your CD
- Early withdrawal penalties: How much interest you’d lose if you need to tap into your callable CD before its maturity date.
Note
Always read the CD agreement before you open a CD. It will tell you whether a CD is callable or not. If it es callable, familiarize yourself with the CD’s maturity date, its callable date, and any applicable early withdrawal penalties.
Pros and Cons of Callable CDs
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Unpredictable compared to traditional CDs
-
Won’t earn all your planned interest if it’s called early
-
Early withdrawal penalties still apply
Pros Explained
- May offer higher interest rates than traditional CDs: Because banks can terminate a callable CD at any time, they may incentivize you to open one up by offering a higher-than-average interest rate.
- Your initial deposit can’t decrease in value: Just like traditional CDs, callable CDs issued by banks and credit unions are insured by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA). So you’re guaranteed to have up to $250,000 of protection across all your deposit accounts at one bank or credit union.
Cons Explained
- Unpredictable compared to traditional CDs: You shoulder more risk with a callable CD because the bank can terminate it, whereas a traditional CD does not have that risk.
- Won’t earn all your planned interest if it’s called early: Many people gravitate toward CDs because they provide a predictable rate of return. But if your callable CD gets called before maturity, you’ll only earn a fraction of what you were originally promised.
- Early withdrawal penalties still apply: Even though the bank can end a callable CD before maturity, you, as the investor, don’t have this option. If you need to dip into funds early, you’ll probably pay withdrawal penalties.
Callable CD vs. Non-Callable CD
| Callable CD | Non-Callable CD |
|---|---|
| Can be terminated by the bank before maturity | Can’t be terminated by the bank before maturity |
| May have a higher interest rate than non-callable CDs | May have a lower interest rate than callable CDs |
| Has an early withdrawal penalty in most cases | Has an early withdrawal penalty in most cases |
The primary difference between a callable CD and a non-callable CD is the presence of a call provision. A call provision gives the issuing bank the right to redeem the CD before its maturity date. If interest rates have failed since you opened the CD, the issuing bank may choose to exercise its right to terminate the CD to avoid paying you a higher interest rate.
However, non-callable CDs don’t have this provision, so the issuing bank can’t redeem them before maturity.
Note
A traditional CD is a type of non-callable CD. Once you open one, nothing changes about the account until maturity.
Alternatives to a Callable CD
There are a few alternatives to consider if you don’t like the unpredictability of a callable CD.
No-Penalty CDs
A liquid or “penalty free” CD allows you to withdraw funds from your CD without incurring any penalties. This type of CD can be a good choice if you think you may need your money before the maturity date. However, there may be limits as to how many free withdrawals you can make.
Step-Up CDs
Step-up CDs have variable interest rates that increase over time. Their rate-increase schedule is revealed ahead of time, so you know ahead of time when your APY will increase and how much interest you’ll earn.
Bump-Up CDs
A bump-up CD gives you the option to increase your rate at least once during your term if interest rates rise. However, you have to request the rate increase with your bank, and it’s not guaranteed.
Key Takeaways
- A callable CD can be ended by an institution before it reaches maturity. If this happens, the institution will return your principal, along with any interest earned up until that point.
- The main reason institutions terminate callable CDs is if interest rates drop.
- Callable CDs often have higher interest rates than traditional CDs because they’re more unpredictable and carry slightly more risk.
- When shopping around for a callable CD, pay attention to the callable date, maturity date, and any early withdrawal penalties.
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