What Does It Mean If a CD Is Callable?

A Certificate of Deposit (CD) is a type of savings account that holds a fixed amount of money for a fixed period, earning interest at a fixed rate. These time deposits are generally considered low-risk investments, often insured by federal agencies up to applicable limits. Some CDs, however, come with a specific characteristic known as a “callable” feature. This article will explain what it means for a CD to be callable and the implications for investors.

Understanding a Callable CD

A callable Certificate of Deposit allows the issuing bank to redeem the CD before its stated maturity date. The issuer can “call” the CD, returning the principal and accrued interest to the investor. This decision rests solely with the issuer, unlike an investor’s early withdrawal which typically incurs penalties.

While this ensures no loss of principal or accrued interest, it means the investor will not earn the interest that would have accumulated had the CD been held to its full maturity. Callable CDs often have longer terms than traditional CDs, but they can be called much earlier, sometimes after an initial “call protection period.”

Reasons for Issuing Callable CDs

Banks primarily issue callable CDs to manage interest rate risk, gaining flexibility to reduce their cost of funds if market rates decline. For example, if a bank issues a callable CD at a 4.5% interest rate and market rates subsequently drop to 3.5%, the bank can call the existing CD and re-issue new CDs at the lower prevailing rate.

To compensate investors for the risk that their CD might be called early, callable CDs typically offer a slightly higher interest rate than non-callable CDs of comparable maturity. This higher yield serves as an incentive, making these products attractive to investors willing to accept the uncertainty of an early call. The additional interest paid ranges, but it can be around 0.5% to 1% more than traditional CDs.

The Calling Process

When a bank decides to call a CD, it provides notice to the investor, usually in writing, informing them of the upcoming call date. This notification typically precedes the actual call, allowing the investor some time to prepare. On the specified call date, the investor receives their principal and accrued interest.

Once the CD is called, it ceases to exist, and the investor no longer earns interest on that particular certificate. The funds are returned to the investor’s designated account, such as a core checking or savings account. After receiving the funds, the investor must then decide how to reinvest the money, which might involve seeking new investment opportunities, potentially at lower prevailing interest rates if the market has shifted.

Evaluating Callable CDs

Before investing in a callable CD, understanding specific terms is important for an informed decision. A “call protection period” is an initial timeframe, often ranging from a few months to a year or more, during which the CD cannot be called by the issuer. This period guarantees the stated interest rate for at least that duration.

Beyond the call protection period, the CD typically has defined “call dates” or a “call schedule,” outlining when the issuer has the option to redeem the CD, such as semi-annually or annually. Investors should also consider the “Yield to Call” (YTC), which represents the return an investor would receive if the CD is called at the earliest possible call date. This metric helps assess the effective return under the most likely scenario of an early call.

Conversely, the “Yield to Maturity” (YTM) indicates the total return if the CD is held until its full maturity date and is not called. Comparing the YTC and YTM provides insight into the potential range of returns. Furthermore, investors should assess the current and projected interest rate environment, as falling rates increase the likelihood of a CD being called, potentially forcing reinvestment at lower rates.