Do today's CD rates present a case for callable CDs?

Callable CDs are generally a one-sided deal: the bank has the option of terminating the CD early, but the customer doesn't. Historically, callable CDs gave the bank the upper hand in dealing with interest rate changes, but today's extremely low interest rates may have changed the one-sided nature of callable CDs. In fact, can a case may be made for callable CDs in today's environment?

How callable CDs work


With a callable CD, the bank has the option of terminating the CD early. For example, a five-year callable CD might give the issuer the option of terminating the CD after two years. If CD interest rates fall, the bank is almost sure to exercise this option. After all, why would it continue to pay you a higher rate when it has the option of adjusting down to lower CD rates?

Callable CDs at low CD rates

Consumers are attracted to callable CDs because interest rates are generally higher than conventional CDs. However, that rate advantage might be short-lived, especially if interest rates fall. In fact, falling interest rates is the biggest risk a consumer faces in signing up for a callable CD. So do today's low interest rates, where even the best CD rates are low, mitigate the risk of callable CDs?

They can. Though there are endless variables of degree and timing, three primary things can happen after you sign up for a CD: rates could fall, rates could stay the same, or rates could rise. Suppose you signed up today for a three-year callable CD paying 0.15 percent above conventional three-year CD rates, with the bank having the option of terminating the CD any time after the first twelve months. Here's what would happen under each of those three interest rate scenarios:

Three callable CD scenarios

  1. If interest rates on CDs fall, expect to see your CD called after a year. Compared to a conventional CD, you'd get the 0.15 percent advantage for one year, but then you'd have to roll over at lower rates. Still, at today's rates, what are the odds of rates falling further, and how far could they actually fall?
  2. If CD rates stay about the same, you win. You'd get the 0.15 percent premium for some or all of the CD term, and even if the bank called the CD after a year, you could still get the same rate you would have received if you had originally signed up for a conventional CD.
  3. If CD rates rise, you wouldn't be able to benefit for three years because you wouldn't have the option of terminating the CD early, but then again, you'd have the same problem if you had signed up for a conventional CD. And, with the callable CD, you'd be getting a little bit higher rate of return in this scenario.

With the risk of CD rates falling from today's best CD rates somewhat limited because they are already very low, callable CDs are a potentially better deal than usual. If rates stay about the same, you would come out ahead and you'd be a little better off than in a conventional CD if rates were to rise.

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