Read the fine print before investing in a callable CD.

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James Chen was the director of investing and trading at Investopedia.He is a global market strategist.

Similar to other types of callable fixed-income securities, a call feature is found in a CD.Callable CDs can be redeemed early by the issuing bank, usually within a given time frame and at a preset call price.When interest rates fall, the issuing bank will stop paying CD holders more than the prevailing rates.

Callable CDs have higher interest rates than regular CDs due to the possibility of the CD being called before maturity, which would result in a loss of interest earnings and pose reinvestment risk.

There are two features of a callable CD, a certificate of deposit and an embedded call option.When interest rates fall, an issuer will try to call back CDs so that they don’t pay interest that is higher than market rates.

A CD is essentially a time deposit issued by banks to investors who purchase CDs to earn interest on their investment for a fixed period of time that may be higher than interest paid on demand deposits.The investor can access the funds when the financial products mature.It is still possible to withdraw money from a CD prior to the maturity date, but this action will often incur an early withdrawal penalty.A CD is considered a low-risk investment as it is usually insured up to $250,000 by the Federal Deposit Insurance Corporation or the National Credit Union Administration.

A callable security is one that can be redeemed early by the issuer.If interest rates go down, a bank adds a call feature to a CD so it doesn’t have to pay a higher rate to the holder.When redeemed early, callable CDs often pay a call premium to the investor, as an incentive for them to take on the call risk associated with the investment.

The call premium is the amount over the par value of the CD needed to compensate investors for the risk of being called away.It is usually priced as an increase in the CD’s yield to investors, and is clearly disclosed as part of the disclosure statement.

The call date is when the bank can call back the outstanding CDs, and it is included in the disclosure statement.

reinvestment risk is created by the addition of call provisions to CDs.If the time deposit is retired early, the investor will have to invest his or her money in a CD paying a lower interest.

As the maturity date of a CD draws closer, the amount of the call premium shrinks.It is a good idea to read the fine print before investing.

If a bank issues a traditional CD that pays 4.5% to the investor, and interest rates fall to a point where the bank could issue the same CD to someone else for only 3.5%, they would be paying a 1% higher rate for the duration of the CD.The bank can use a callable CD to issue a new CD at a 3.5% yield.

The bank will not be able to retire the 4.5% CD until six months have passed since it was issued.There is a guarantee that 4.5% interest will be paid for at least half a year.The loss of the higher interest rate will be mitigated by the lump-sum call premium the bank pays to the CD holder.

The U.S. Securities and Exchange Commission.”High-Yield CDs: Protect Your Money by Checking the Fine Print.”It was published Feb. 25, 2021.