Callable Certificate of Deposit: Be Wary

Barbara Marquand | guest writer for GoTalkMoney

With the best one-year CD rates below two percent, callable CDs, with rates upward of five percent, can look awfully attractive. But look before you leap. These investments have major catches that in many cases wipe out any benefit from a higher yield.

Here are key points to consider:

Callable Certificate of Deposit: What Exactly Is It?

"Callable" refers to the bank's ability to terminate, or "call," the CD. At that point the bank will return the cash you've invested, along with the interest accrued so far, even though the CD's regular term is not up yet. Only the bank can call the CD. You'll have to pay a penalty for cashing in the CD before it matures.

Interest Rates

Callable CDs often offer higher yields because they generally have long terms, and longer-term CDs usually furnish higher interest rates than short-term CDs. They also feature higher yields because banks have the option to back out of the arrangements. You'll need to weigh those factors when you compare interest rates of callable CDs with conventional CDs and decide whether the callable feature and the long term are worth the investment yield.

Maturity Date

Make sure you understand when the CD matures. It's easy to get confused with callable CDs, and some brokers have come under fire for misleading clients. For instance, you might assume a "one-year non-call" CD is simply a one-year CD. But the one year refers to the amount of time that must pass before the bank can terminate the CD. It does not refer to the maturity date. That one-year non-call CD might have a term of 20 years -- even 30 years. Carefully read the fine print describing the certificate of deposit to determine how long your money will be locked up. Consider the risk you're taking if interest rates rise. With a short-term CD, you can get your money out to reinvest in a higher-yield vehicle. With a callable CD, you're stuck with the low rate, possibly for decades.

When Can the Bank Come Calling?

A callable CD stipulates the non-call time -- the number of years that must pass before the bank has the option of terminating the CD. After that period a bank might call its high-yield CDs if interest rates drop.

Early Withdrawal Penalty

The early withdrawal penalty for callable CDs is heftier than for traditional CDs, as much as 25% of the principal. That combined with the long term are among the factors financial experts advise against these investments for older people. The North American Securities Administrators Associations tells of a retiree in Iowa who invested more than $100,000 of her 97-year-old mother's money in three callable CDs. She wanted to use the money to pay her mother's nursing home bills, not realizing the CDs had 20-year terms and big early withdrawal penalties.

Investments and Your Financial Goals

As with any investment, consider callable CDs in the context of your financial goals. How would they fit in with the rest of your portfolio and investment timeframe?

Know Your Certificate of Deposit Broker

Callable CDs are marketed through brokers, and because deposit brokers aren't licensed, anyone can call himself one. The U.S. Securities and Exchange Commission says to check the background of any brokers or companies you're considering. Also, know which financial institution is offering the CD to make sure it is FDIC-insured. Your deposits are insured for up to $250,000 per FDIC-insured institution.

Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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