If you have cash in savings that isn’t reserved for emergencies or short-term goals, then that money could find a cozy home in one of today’s top-paying certificates of deposit (CDs). CD rates are rarely as high as they are today, with the best 12-month CDs paying out above 5.00% APY. These rates are projected to drop lower in the near future, making now a good time to lock in before it’s too late.
That said, not every type of CD will benefit you in a high rate environment. While traditional CDs will lock in your interest rate until the end of your term, callable CDs could leave you earning far less than you were expecting. If you’ve never heard of callable CDs before, here’s why you should watch out for them.
Callable CDs offer generous rates, but they don’t offer any long-term guarantees
At first glance, callable CDs seem to work just like traditional CDs. They offer a fixed interest rate, come in various terms, protect your money with FDIC or NCUA insurance, and have early withdrawal penalties. Interest in callable CDs is usually compounded and may be credited to your account monthly or quarterly.
What makes callable CDs different, however, is their call option. This gives the issuing bank or credit union the right to call or redeem the CD before its maturity. If your CD is called, your initial deposit and interest will be returned to you or repackaged into another CD with a lower interest rate. If this happens, you would stand to gain less interest than if the same CD had reached its maturity.
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For example, let’s say you find a 1-year callable CD with a 5.25% APY. When you read the fine print, you find out the bank will have a call option with a call date that’s six months from the day the CD is issued. You get the CD, and, six months later, CD rates on 1-year terms have dropped significantly to a median of 4.00%. As expected, your bank calls your CD and reissues it with a 3.80% APY.
Notice the callable CD from above has a “call date.” Banks typically can’t just call a CD whenever they want. Often, they give you a protection period, during which they won’t redeem your CD, along with a call date on which they can. The longer a callable CD’s term, the more call dates it might have. The protection period gives you some time to earn at a guaranteed interest rate, but the call dates could change that in a heartbeat.
Many traditional CDs have better rates right now
In truth, the purpose of callable CDs is to prevent banks from paying high interest after ongoing rates have declined. For this reason, they might offer slightly higher rates on callable CDs. This might entice you to get one, but, again, the rate isn’t guaranteed for the duration of your term. In fact, since interest rates are expected to decline soon, today’s newly issued callable CDs will likely be called. Getting a callable CD today, then, could mean leaving interest on the table later.
This argument for callable CDs (that they have higher rates) has been severely weakened by the plethora of great CD rates on the market. These days, it’s not uncommon to find 12-month CDs paying at or above 5.00% APY. Since even the best callable CDs are still on par with their traditional CD counterparts, it doesn’t make much sense to get one, especially if CD rates decline in the near term.
A better strategy would be to build a CD ladder. With a CD ladder, you divide your money among several CDs with staggered terms. For example, you could deposit $1,000 equally in a 6-month, 1-year, 18-month, 2-year, and 3-year CD. This helps you gain access to your money at regular intervals, while also taking advantage of APYs on longer-term CDs.
All in all, if you’re considering getting a callable CD, be sure you understand the details. Read the fine print and make a note of its call dates and protection periods. Compare its rate to traditional CDs, as the difference in interest may not be significant enough to take on the risk of your CD being called.
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