How wise is it to invest money in a callable CD?

CD rates seem to be declining in the past few months. But irrespective of the decline, most of the people are still pumping money into Certificate of Deposits due to limited investment options. Additionally, these deposits are considered the safest bets as they are covered with FDIC insurance for a maximum of $250,000 per individual unit of deposit.

What is the benefit of investing money in a Certificate of Deposit? Most of the people are looking forward to maximize their income by weighing out the risks involved in investing in various types of CDs. The same could be achieved by a CD ladder or by investing money in a Callable CD.

What is a Callable CD?

A callable CD is similar to a traditional CD with a fixed rate of interest, but with a major difference. In a Callable CD, the bank offers the option of redeeming or withdrawing the money invested prior to the date of maturity, if interest rates decline. However, the CD is offered with a call protection feature where it remains practically untouchable for a specific period of time. But as soon as the expiry of the call protection period or lock-in period, the banks can close the prevailing CD account and reinvest the amount in a new CD at lower rate of interest. Callable CDs are offered 1% higher rate than other CDs.

Callable CDs are subjected to certain risk. In spite of the high rate yield by these CDs, the important factor to be noted is that the issuing authorities have the power to recall the CD at any time on expiry of the call protection period, which might affect the investment.

For instance, if you purchase a 24 month Callable CD offered at 6% interest rate with a call protection period of 4 months. You can opt for two decisions.

If the CD rate declines to 4%, after expiry of the call protection period, the bank will definitely call your CD giving an option of re-investment at 4% and the bank has the savings of 2% interest. And you will earn 2% reduced interest for remaining 20 months. But if you have invested in a regular CD at the rate of 5% lower the initial rate of 6% offered with Callable CD, your earnings would be comparatively high.

The second scenario, if the CD rates increases to 7.5%, after 6 months, the bank will not call the CD and you will be earning the higher yield for rest of the period until the date of maturity. But when it comes to traditional CD, the increased interest rate has no effect until the maturity of the CD.

If the investment is vested with risk, don’t forget that it is the best possible way where you have the option of maximize the potential earnings.

The costlier mistake made by the investors in purchasing a callable CD is the simple case of misunderstanding. They often get confused with the callable date and maturity date. For instance, the term ‘callable one year’ is often misunderstood by investors as the CD matures in a year. So, before investing your money in a Callable CD, make sure that you have understood the terms and facts clearly.