How to Evaluate a Callable CD
January 01, 2008
Many people who are anxious about the stock market's gyrations plan to put their cash in certificates of deposit (CDs). Banks usually offer higher rates of interest on CDs than regular savings accounts. For a higher yield or return on your investment, you might be interested in a callable CD. Use these comparison shopping tips to find the best CD investments for your situation.
CDs: Less Risky Than Stock Investments
Brokerages and independent salespeople also offer CDs. The advantage of these investments is that they carry less risk than stocks and mutual funds. The Federal Deposit Insurance Corporation (FDIC) insures many CDs.
CD Call Date versus CD Maturity Date
Callable CDs pay a fixed interest rate just like regular CDs. However, callable CDs also include what is referred to as a call option, which means the bank that issued it can redeem your CD (buy it back from you) for the full amount before its maturity date. The CD features what is sometimes referred to as a "call protection period" during which it cannot be called. After that period, the CD can be redeemed by the bank if it chooses to do so.
Do NOT confuse the call date with the maturity date. For example, a "12-month callable CD" may tie up your money for years--the "12 months" refers to protection period, not the entire term of the investment. Mixing the two up could get you stuck with penalties for early withdrawal if you though the money would only be tied up for 12 months.
Why Call Back a CD?
So why would the bank call a CD? If you buy a CD from your bank that pays you 6% interest, and rates drop so that the bank could sell new CDs paying only 3%, it might call yours and save itself 3%. This feature lowers the risk to the bank--if rates go up, it still only has to pay you 6%. If rates go down, it can get out of the deal and get cheaper financing with new CDs that pay less.
Callable CD Investments: What's in it for You?
Because this feature gives banks added security, they compensate investors who buy callable CDs by paying a better interest rate. And if rates don't drop, you win--because you get the higher rate and your CD doesn't get called.
What Should You Look For?
The best CD investments are the ones most appropriate for your situation. Then choose the best rates from the CDs in that group. Also consider:
- The background of the person selling you a CD--there is no licensing or certification requirement to sell them. You can check credentials with your state securities regulator.
- The maturity date and early withdrawal policy to find out what kind of fees you might have to pay.
- The interest rate--make sure the callable CD pays better interest versus a regular CD. If you don't want to be concerned with interest rate changes then a regular CD may be the right choice.
- Your other accounts--make sure that if you buy a callable CD at a bank where you have other savings accounts, the total of all accounts doesn't exceed the FDIC insurance limit, which is currently $250,000.
Do your homework before committing to a callable CD or any investment product to avoid any problems and find the highest CD rates.