A callable CD is a type of certificate of deposit where the issuer can call the investment before the CD reaches its full maturity. Calling a CD, like calling a bond, means the issuer has the discretion to redeem the CD and pay only the principal and interest it earned to that point. For the investor, a callable CD holds a higher risk than other types of CDs because you will not receive a guaranteed rate of return should the issuer call the investment. On the other hand, because of the higher risk involved, callable CDs typically pay a higher rate of return.
Standard CD
With a standard CD, you deposit a specific amount of money with a financial institution. When you purchase the CD, you designate a date of maturity, and upon maturity, the financial institution will pay back your deposit with a specified rate of interest. With most CDs, after maturity, you can either withdraw your interest principal or roll the account over into a new certificate of deposit.
Call Features
The details regarding the features of a call usually vary per the terms of the certificate of deposit agreements. Some CDs only allow the issuer to call them during an initial period, for example, during the first year. Other types of callable CDs allow the issuer to call them after an initial period or up to a certain amount of time prior to the maturity date. Further, other types of CDs have a periodic, revolving call window, allowing the issuer to call the CD during specific windows of time throughout the life of the CD.
Variable Rate CDs
Another type of callable CD is a variable-rate certificate of deposit. This type of callable CD automatically resets at lower rates based on a specific index, such as the Treasury rate or the London Interbank Offer Rate. Variable rate CDs protect the bank from lower interest rates by resetting should interest rates fall. At the same time, variable rate CDs can also benefit the depositor should interest rates rise. With rising interest rates, the variable rate CD will reset with a higher interest rate paid to the depositor.
Investor Risks
While rates on callable CDs can be significantly higher than standard CDs, all the risk lies with the investor. Unlike a standard CD, where you could potentially lock in a high rate of interest over a long period, in times of falling interest, not only is the CD likely to be called before paying full interest; the investor will now have no choice but to reinvest that money at lower rates.
