What is a callable CD? What to know about the risks

Many CDs offer a fixed interest rate, so you can lock in an annual percentage yield (APY) that won’t fluctuate because of market volatility or changes to the Fed’s benchmark rate. Bank CDs are generally considered low-risk investments, but if you opt for a callable CD instead, you might be taking on more risk than expected.

What is a callable CD?

When you open a traditional bank CD, you deposit a set amount of money for a fixed period of time, typically ranging from a few months to the entire sum of the accrued interest. In return, you’ll earn a fixed APY (unless you have a variable rate CD), with interest compounding on a daily, monthly, or semi-annual basis.

Callable CDs work similarly although there’s one key difference: they carry a call feature. This means that banks can terminate the CD before it matures. Banks usually have to wait a defined period of time before they’re able to call a CD.

If a bank does call your CD, you get to keep the principal (or the amount you initially invested) and the interest payments you’ve accrued up until the date it was called. You won’t get the remainder of interest you would have earned had the CD reached maturity.

Why choose a callable CD

So why might a bank choose to “call” a CD? Callable CDs are typically called when interest rates drop.

Let’s say that a bank offers a 3-year CD with a 5% APY. However, one year later, that APY drops to 3%. The bank might call your CD because it can issue new CDs with a lower interest rate. You’ll then have to reinvest your money somewhere else. Callable CDs offer higher APYs than traditional CDs because of this risk, which is known as reinvestment risk.

You might opt to buy a callable CD if you think interest rates will increase or stay steady in the future, but investors might find it challenging to predict how rates will change in the future. 

“It’s very difficult to gauge where rates will be at any point of time from now,” says Scott Sturgeon, founder of Oread Wealth Partners. “People who try to predict this stuff are often incorrect…There are other low-risk assets you can utilize that might be a better fit.”

Traditional bank CDs are safer than callable CDs, but they typically offer lower rates. If you’re willing to give up some of your return for less risk, these banks and credit unions offer some of the best CDs:

How does a callable CD work? 

Callable CDs are available at banks and brokerages, but most callable CDs are offered by brokerages. You can buy a callable CD by either opening a brokerage account (and then purchasing one) or directly investing in one from a bank. 

You can find brokered CDs at brokerages such as Vanguard, Charles Schwab, and Fidelity. Thanks to the Fed’s rate fluctuations, some of these institutions are offering CDs with rates well above 5%. CDs are FDIC-insured up to $250,000 per depositor, per bank.

Depending on the brokerage, you may be required to invest a minimum amount of money to start. And if you’re opening a callable CD at a bank, there may be a minimum opening deposit. 

When buying a callable CD, you can choose the CD’s term length and be given information about the APY. You’ll want to pay close attention to the call period or call date, which tells you when the bank is able to call your CD. For example, if you have a 5-year CD, the bank may have a call period of two years. This means the bank cannot call the CD within the first two years.

Note that CDs sold by brokerages have different features than bank CDs, so if you’re opting to buy a callable CD through a brokerage firm versus a bank, there are a few differences you want to be aware of. Many callable CDs are brokered CDs.

What is a brokered callable CD?

CDs sold by brokerages are known as brokered CDs. They work like this: Banks issue CDs in bulk and brokerage firms buy those CDs in order to sell them to customers. Some brokered CDs have a call feature, so the bank that initially issued the CD can redeem it before it reaches maturity.

“Since they [brokered CDs] are purchased in a brokerage account, you could have an original issue—where you’re buying it when it is issued—or you could be buying it on a secondary market,” says Peter Salkins, Financial Planner at Integrated Partners. 

Brokered CDs typically offer higher APYs and greater liquidity than bank CDs. Unlike bank CDs that require you to pay a penalty fee for early withdrawal, brokered CDs can be sold on the secondary market before they mature. This feature can be useful if you think you’ll tap your money before the CD reaches maturity and want to avoid paying an early withdrawal penalty. 

However, depending on whether interest rates have risen or fallen since you purchased the CD, you could make a profit or lose money when you sell a brokered CD on the secondary market.

Brokered CDs are usually FDIC-insured, but you’ll have to figure out which bank issued the CD to guarantee that it is insured. The SEC also recommends that investors look into the deposit broker’s background to ensure they are reputable. 

Pros and cons of callable CDs

Before you invest in callable CDs, it’s important to understand some of the tradeoffs.

What is the difference between a callable and a traditional CD?

A callable CD can be terminated by a bank before it reaches maturity, but you’ll usually get a higher rate in exchange for taking on this additional risk. If you prefer safety and a lower return, traditional bank CDs currently offer solid rates and cannot be called.

If you withdraw money early from a traditional CD, you’ll have to pay a penalty that is typically worth a few months of interest. Since many callable CDs are brokered CDs, you can’t make an early withdrawal from a brokered CD, so you’ll have to sell it on a secondary market instead.

Frequently asked questions

Can you lose money on a callable CD?

It depends. If you hold a CD that the bank calls because interest rates have dropped, you get to keep all of the interest you’ve accrued plus the principal. In this scenario, you won’t lose any money, but you’ll have to figure out where to reinvest your money, which could be in a new CD that offers a lower APY.

Another instance where you could lose money is if you wanted to sell a callable brokered CD before it reaches maturity. Depending on if interest rates have risen or fallen since you purchased the CD, you could incur a profit or loss on your sale.

Should you buy a callable CD?

It depends. If you’re fine with the possibility of your CD getting called and want a higher APY, it could be a good bet. On the other hand, if you don’t want to deal with the hassle of figuring out where to reinvest your money if it does get called, a traditional CD is a better choice.