A callable-CD is the one where the bank or other financial institution issuing the certificate of deposit (CD) has the option of recalling the CD well before the maturity date. This type of investment can yield good returns if the portfolio is managed properly.
Here, it is important to understand the pros and cons of Callable-CDs so as to make a wise investment decision.
Lower interest rate scenario: The primary reason for redeeming the CDs is the changing interest rate. Once the CD is called back, the depositor gets back the principal amount along with the interest. There are opportunities where the investor will be at a disadvantage if interest rates fluctuate either way to a significant amount. If the interest rates drop, the CD is called back. The investor is now left with the option of reinvesting the returned amount at a lower interest rate.
High interest rate scenario: In case the interest rates rise, the investor needs to wait for years until the CD matures. During this entire period, the certificate of deposit pays interest rate that is well below the existing market rates. In case of callable-CDs, the investor or the depositor does not have the option of calling the CD. If the investor surrenders the CD with the bank before maturity date, he / she needs to pay surrender charges. The investor does not even have the option of selling CDs before maturity when the interest rates are on a high. Nobody would be interested to pay higher interest rates and buy a CD. Even if one agreements, there will be a significant principal loss.
Callable CDs with a longer non-callable period are more advantageous to the customer because this is the period where the bank is bound to pay higher interest rates on the deposited amount.