How a Callable CD Affects You
Callable CDs are Certificates of Deposits that typically have a high yield associated with them. However, these CDs have a call provision which allows the bank the option to call back or mature the CD early if holding your deposit is no longer beneficial. Unfortunately, this call option can only be exercised by the issuing bank and only after the call date has passed.
You purchase a $50,000.00 CD with a rate of 5.5% paying interest semi-annually with an actual/360 day count and final maturity ending in 20 years that is callable after 2 years. Three years into the life of your CD rates drop drastically to 3.5%. Your bank realizes they can now have the use of $50,000.00 at a rate of 3.5%, so they will exercise the call option. Your bank will mature your CD and now you are out an additional 17 years worth of interest at a rate of 5.5%. You always have the option to purchase another CD but you still lose out on the 2.0% you could have earned with your previous deposit. Anyway you look at it you lose out on potential earnings.
The flip side of this is if rates increase during the life of your CD, you can terminate your CD early, however you will do so with a penalty that is determined by your bank. Meaning, you could stand to come out with less accrued interest or even less on your principle deposit at the time of maturity. Again, you stand to lose a little, on the other hand you will make it up by purchasing another CD at the new higher rate.
Another issue with callable CDs is that the call date is often confused for the maturity date. To curtail such confusion have your broker or dealer explain the exact terms of your CD to you before you finalize the terms. I recommend also going as far as requesting documentation to be sent to you clearly defining the details such as:
• Principal/Par (the amount you deposit)
• Call date and explanation of what this means to you
• Maturity date
• Day Count
• Coupon Payment cycle