Callable CDs—There are so many different options for investing money into certificate of deposits. Investors have to do their research before making a decision. Just about any CD that they choose can have a series of advantages and disadvantages. Investors must carefully consider their personal needs for the present and the future to determine the best investment options for their money. CDs have always been an excellent choice for the investors who want to see their money grown over time.
How do Callable Certificate of Deposit CDs Work?
Callable CDs are investments that investors make with financial institutions. These deposits are time deposits in which the issuer controls. The investor agrees to invest the money for a fixed amount of time with a specified interest rate for the return. The difference between traditional CDs and callable CDs is that callable CDs give the issuer a great deal of control over the investors’ money. The issuer may redeem callable CDs before the maturity date.
For example, consider a financial institution issued a CD in 2010 at an interest rate of 8%, maturing in 2020, and callable in 2015 at 103% of the face value. 5 years from issue, the financial institution has the right to call the CD, which financial institutions usually do if the interest rates are under 8%. The issuer usually must pay the investor a little above the face value, or par value, in order to call the CD. The difference is what financial institutions call the call premium. The amount decreases as a CD approaches the maturity date. For example, a financial institution may offer investors 103% of par value in the event the CD is called in 2015, but it may decrease the offer to 102% if the CD is called in 2018.
Advantages of Callable Certificate of Deposit CDs
- Investors receive higher rates for a fixed amount of time. Callable CDs have the right to receive the benefits of a high CD interest rate even when rates lower. If a CD purchased in 2011 has a callable date of 2015, the financial institution must continue to offer the high interest rate to investors, even if the current market rates are significantly lower.
- The interest rates are higher than traditional CD rates. Callable CDs usually are 0.5% to 1% higher than traditional CDs are. Financial institutions use this increase as a marketing scheme to convince investors to invest their money. Investors can earn a higher return on callable CDs than they do on traditional CDs.
- The investors do not lose principle. Even if the financial institution calls the CDs, the investors still walk away with all of their principle that they originally put into the CDs. Callable CDs are still a better investment option than gambling with the stock market.
- Investors receive par value once the investor calls the CDs. Investors may receive a higher value for the called CD. Financial institutions pay a call premium that is usually a little over the par value. Investors may earn 103% of the value of their CDs.
Disadvantages of Callable Certificate of Deposit CD
- There are early withdrawal penalties and longer terms on callable CDs. Callable CDs have longer terms so they offer higher returns. Investors may lose money if the market value increases while they are stuck with the long-term CDs. If investors take out their money before the maturity date, they stand to lose a large amount of interest. Banks change as much as a 25% early withdrawal penalty to investors.
- Investors may lose future interest. Even though the financial institutions pay par value, investors still lose the opportunity to benefit from future interest gains. Financial institutions reserve the right to allow investors to reinvest the money into other CDs.
- Anyone can market callable CDs. Callable CDs are generally marketed through brokers. Deposit brokers are not required to be licensed. Investors must conduct background checks into the businesses and brokers in which they entrust their money. Also, if the bank is not FDIC ensured, investors stand to lose a great deal of their money in the investment.
Callable CDs are more enticing to investors because they offer higher interest rates than traditional CDs do. There are many advantages and disadvantages to choosing callable CDs. Investors must make sure that they understand the difference between traditional and callable CDs. Some financial institutions may call callable CDs one-year non-call CDs, for example. The terminology just means that the CDs are callable after one year. Invest wisely!