I generally don’t like Certificates of Deposits because the math doesn’t make sense, but I received an e-mail today about Callable CDs that made me really mad. I had heard of Callable bonds, but don’t have any recollection of a Callable Certificate of Deposit, so I figured I would share what I learned about them and the e-mail that angered me.
What is a Callable CD?
Investopedia provides a very easy definition for a Callable CD,
Just like a regular CD, a callable CD is a certificate of deposit that pays a fixed interest rate over its lifetime. The feature that differentiates a callable CD from a traditional CD is that the issuer owns a call option on the CD and can redeem, or “call”, your CD from you for the full amount before it matures.
So like a regular CD the bank is going to take your money and lock it up; for this they allegedly provide a higher interest rate. But in a Callable CD the bank can “call” the CD and give you back your money early, or the bank could choose to let the CD stay till the maturity date. So essentially, the Bank is shifting the risk that interest rates will change to you, the consumer.
Watch out for Callable CD Advertisements?
I received this email today in my capacity as a Registered Represented,
Dear Representative,
For your clients that expect interest rates to rise over the next few years, please consider the following Step Up CD investments. These instruments are designed to step-up in coupon at pre-determined dates and percentage increments. The Advisor offering these to their client must be Series 7 Licensed.
***
Offering
ABC Bank Step Coupon CD Maturing 10/16/2017
Callable 4/14/11 @ 100
The Coupon starts at 1.5% through 4/13/2011 and then steps up at the following rates
2.000% to 4/13/12
2.500% to 4/13/13
3.000% to 4/13/14
4.000% to 4/13/15
5.000% to 4/13/16
6.000% to 4/13/17
7.000% to 10/16/17
This CD distributes income monthly and may be called @ PAR annually.
Offer the CD @ PAR = 1.5% YTW 3.54% YTM. Compare to the two year treasury at 1.06% and the 7 year treasury at 3.33%
Woah, so let me get this straight:
- ABC Bank you are going let give you money to ‘lock up’ for 1.5% for the next year (ING is paying 1.1% so you are LOCKING UP MONEY FOR .4%?)
- At that point if current interest rates are above 2% you won’t call my CD? And you’ll keep the cheap money…BUT
- If the prevailing interest rates are below 2% you’ll call the CD give me my money back and sell a CD to another Sucker.
The bank is essentially shifting interest rate risk to you, for next to no money and with NO guarantee that you’ll ever see those larger interest rates. Does anyone believe that interest rates are going down? If not, then why would anyone use this product?
Readers: Am I missing something? Has anyone used a Callable CD in their Investment/Cash Portfolio?
It’s like a reverse teaser rate! In this case putting the huge interest rates at the end, trying to sucker people into buying now. I can’t think of any situation this would favor the buyer.
5 year CDs are around 3% right now, that would seem to be the better play.
So it isn’t me, right? This product sucks. I usually like to say IF a product exists it has to have some utlility for somone. I have used that line of reasoning for Variable Universal Life, Variable Annuities, Whole Life, etc. (of course I can provide instances when it would help someone). But, I can’t figure out WHEN this would help ANYONE!
I think they are banking on customers who have very bad math skills… People see that end rate, and jump in without doing the math…
Perhaps they are thinking “Tricking the customers, Good times…”
This is my first exposure to the concept of callable CD’s. Thanks for sharing. It doesn’t sounds to enticing unless you can get an extra good interest rate for the time you take the CD out
I have callable CD’s. My objective is to get the most interest possible with FDIC backing. I’m currently getting between 5 – 6 percent on 5 long term CD’s. These were purchased for my IRA approximately 2 years ago. It’s a small percentage of my overall income oriented portfolio. If you want to poo-ppo that, you are welcome to do so. But I will be collecting my quarterly interest rates while you go and try to get that rate elsewhere – good luck. I’ll take the risk of being called but meanwhile I’m collecting 5 times the going CD rate. I’ll figure out what to do when the problem arises. I’m sure my investment folks will find something that pays more than 1%.
The examples above do not necessarily illustrate the unique utility of Callable CD. I have an elderly relative who needs to be 100% assured of the RETURN of her investment. We have successfully purchased six Callable CD (all FDIC insured) which guaranteed initial interest rates in the 7 to 9% range for the first year. We consciously sought after Callabel CD which variable index calculations suggested the likelihood that they woudl be called and in all six cases the call was issued on the first anniversary. We have been very successful in increasing her interest income by more than over 10x what traditional CD would have paid out. I am looking to purchase a new issue this week and have been reviewing Callable CD’s in the range of 8.5 to 10% (fixed for the first year) 15 & 20 yr terms. The buyer needs to be careful to fully understand the variable calculation. Many are hinged on certain market indexes being over a certain threshold. It is useful to go back to 2008 and see how these indexes performed to understand how long you might have foregone an interest payment. Callable CD’s are like a one iron, you hope you never need to use it, but it is good to have some skill in the event you need to.