What is a callable CD?
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Updated: November 16, 2023
A callable CD (certificate of deposit) is a type of low-risk investment. While you generally receive a fixed interest rate, the issuer can terminate the CD before its maturity date. If this happens, you’ll still receive your initial investment (principal) and any interest earned until that point. You just won’t receive future interest payments.
In contrast, a traditional CD cannot “call back” the loan early. Given the risk of losing potential earnings, callable CD interest rates tend to be 0.5% to 1% higher than regular certificates of deposit. The higher rates compensate investors for the added investor risk. This guide will walk you through everything necessary about callable CDs, including how they work, their pros and cons, and the best alternatives.
Callable CD definition
A callable CD, or certificate of deposit, is a low-risk investment that generally has a fixed interest rate. The downside is that the issuer can terminate the CD before its maturity date. If the CD is called early, the investor receives their initial investment (principal) and any interest earned until that point, but future interest payments are forfeited. Callable CDs usually provide higher interest rates than regular CDs to account for the increased risk of early termination.
How do callable CDs work?
When you invest in a callable CD, you'll select a term, like 12 months or five years, and deposit your money. Most CDs have a minimum deposit requirement of $500 to $1,000, which is generally FDIC-insured. An initial non-callable period prevents the issuer from terminating the CD too early. This is followed by the callable date, the earliest date the issuer can “call back” the CD. After the callable date, the issuer can terminate the CD before it reaches maturity.
While issuers may not always terminate the CD during the callable window, they have the option to. If the issuer terminates the CD before maturity, you’ll receive your initial investment principal back and any interest earned until then. The issuer will generally only terminate the CD early if interest rates drop throughout your term. This is because they can refinance their cost of financing to a lower interest rate loan.
To illustrate how a callable CD works, let’s assume you deposit $10,000 into a five-year callable CD with a 4% APY. In the first two years, you earn $816 in interest. After two years, the CD enters the callable period, and the issuer terminates it. At this point, the bank returns your $10,000 principal and the $816 interest earned until that date. You won’t earn the remaining three years of interest but can immediately reinvest into another CD.
While issuers can terminate callable CDs early, investors face more restrictions. You usually cannot withdraw your money from a callable CD without facing an early withdrawal penalty (EWP). These penalties can be steep, such as forfeiting several months' interest. Some investors use a CD ladder strategy to avoid penalties, which avoids locking all your funds away in a long-term investment.
Important terms to know
- Callable date: The earliest the bank can terminate or "call back" the CD. There's usually a non-callable window before the callable date.
- Maturity date: This is the full term you agree to invest for, like five years. You’ll receive your initial investment and any interest earned at the maturity date. You will not reach the maturity date if the CD is called before.
Annual percentage yield (APY): CD interest rates are commonly expressed as an APY. This is your investment return when considering compound interest.
Callable vs. non-callable CDs
In general, callable CD interest rates are 0.5% to 1% higher than non-callable CDs because there is a risk of the issuer terminating it early. Issuers benefit from callable CDs if interest rates drop during the term. This is because they can terminate the CD and refinance to a lower cost of borrowing. As an investor, this is less beneficial to you.
For example, let's assume market interest rates drop during your term, and the issuer terminates your CD. As the investor, you would be forced into a lower-rate environment and lose the higher interest rate you initially expected.
With a non-callable CD, you will maintain the higher interest rate, even if market rates decrease. As such, non-callable CDs are with it to lock in a guaranteed rate if you expect decreases throughout your term. However, callable CDs generally provide higher interest rates to compensate investors for this risk.
As the investor, both callable and traditional CDs have restrictions on early withdrawals. This means you’ll experience penalties for withdrawing your funds before the maturity date. While the penalties vary, they’re generally a few months’ interest earned. The penalties increase with the duration of your CD. This means a five-year CD will have more significant penalties than a one-year CD.
In addition, both options are FDIC-insured. This means your deposits are protected up to $250,000 per financial institution. Depositing more than this amount in the same institution can revoke protection on the incremental amount.
Pros
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Higher interest rate
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FDIC insurance
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Fixed interest rate
Cons
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Call risk
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Early withdrawal penalties
Pros:
- Higher interest rate: Callable CDs tend to offer higher interest rates than regular CDs because of the call risk.
- FDIC insurance: Callable CDs are FDIC insured just like traditional CDs, so your principal is protected up to $250,000 per insured bank.
- Fixed interest rate: The interest rate on a callable CD is generally fixed for the CD term, providing more predictability.
Cons:
- Call risk: If the bank calls the CD before maturity, you lose out on any remaining interest payments. This call risk is the tradeoff for the higher rate.
- Early withdrawal penalties: Withdrawing funds early from a callable CD is subject to penalties. You can avoid penalties only if the bank calls the CD first.
Alternatives to callable CDs
A callable CD is a low-risk investment with a fixed interest rate. While the issuer can terminate your CD early, investors have penalties for early redemption. As such, alternatives are available to investors who prefer higher interest rates or flexibility.
Traditional CDs
Traditional CDs lock in your money for a set term, without the risk of early termination. However, they offer lower interest rates than callable CDs. Minimum deposits are generally around $500 to $1,000. Withdrawing early incurs a penalty of several months of interest.
Jumbo CDs
Jumbo CD interest rates are higher but require an initial deposit of around $100,000. They are available as callable or traditional CDs. Withdrawal penalties still apply for early termination.
No-penalty CDs
No-penalty CDs allow you to withdraw funds without any early withdrawal penalty. You’ll generally receive a lower interest rate than a traditional and callable CD in exchange for the flexibility.
Variable CDs
Variable-rate CDs have interest rates that fluctuate based on an underlying index, such as the Prime Rate. The interest rate may change monthly, quarterly, or at other intervals. This allows investors to benefit from rising interest rates. However, variable CD rates can also decrease when rates decline.
Brokered CDs
Brokered CDs are offered through brokerage firms instead of through banks. The brokerage firm purchases a large block of CDs from banks and resells them to investors in smaller pieces. As an investor this streamlines investing by letting you purchase through your trading account rather than a bank. While brokered CDs are also callable, investors can trade out of them without penalties. As such, they provide a great combination of convenience, flexibility, and a higher interest rate.
High-yield savings accounts
High-yield savings provide the easiest withdrawals to your money but generally have the lowest interest rates. They generally have low or no minimum balance requirements. However, interest rates fluctuate more than CDs, which have a fixed rate.
Money market funds
Money market funds invest in a basket of short-term securities like the ones mentioned in this section. They provide diversification across various short-term instruments. The major differences from callable CDs are money market funds have flexible withdrawals, variable returns, and no FDIC insurance.
Bonds
Bonds are a broad category of debt securities. They function differently than CDs but can also provide predictable income. Short-term bonds are considered less risky and have lower interest rates than long-term bonds. You can commonly trade bonds on secondary markets, meaning they provide more redemption flexibility than CDs. Some of the most common types of bonds are:
- Treasury Bonds: These are issued by the U.S. government and are considered one of the safest investments.
- Municipal Bonds: These are issued by local governments to fund projects. Interest is generally tax-exempt.
- Corporate Bonds: Corporations issue bonds to raise capital, paying investors periodic interest. These carry higher risks than government bonds if the company defaults.
- Bond Funds: These invest in a diversified basket of bonds from issuers like the government or corporations. Investing in a bond fund provides greater diversification. Bond funds have no set maturity date.
Callable CD FAQs
Daniel is an expert on travel, finance, and SEO. He received an Honours BBA (Finance) from Wilfrid Laurier University, then started his career with WOWA. Here, he learned various SEO tactics that were instrumental in quadrupling monthly traffic to one million views. Now the founder of Croton Content, Daniel helps financial companies scale through evergreen content. Aside from Money Wise, notable clients include Forbes Advisor, WealthRocket, and Hardbacon. Daniel loves to travel when not working. Although based out of Lisbon, Portugal, some of his most adventurous destinations include Rio, Cairo, and Istanbul.
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