J.R.Whalen: Here's your Money Briefing for Friday, October 4th. I'm J.R. Whalen for The Wall Street Journal. As the Federal Reserve raised interest rates, high-yielding certificates of deposit or CDs became a hit with investors, some offering more than 5%. But as rates trend downward, banks are calling some of those CDs. And for many investors, those attractive rates are going away.
Imani Moise: When people purchase CDs, they're locking in a rate for a term. That could be one year, that could be five years. But if rates fall, that means that banks are stuck paying you that higher rate when they could just refinance it and get that money for cheaper.
J.R.Whalen: Wall Street Journal Personal Finance Reporter, Imani Moise, will join us to discuss what you should know about callable CDs after the break. Some people who poured money into the highest yielding CDs are seeing those attractive rates start to come down. Wall Street Journal Personal Finance Reporter, Imani Moise, joins me. Imani, which types of CDs are involved here?
Imani Moise: The only CDs where you have to worry about interest rates falling are callable CDs. And what will happen as market rates come down is the bank has the option to call your CD, which means that they'll repay you early with all of the interest that you've accrued to date, but you're missing out on that high yield that you thought you'd locked in. Most CDs are not callable, but all callable CDs are brokered CDs. And what that means is the CD that you get not directly from your bank, but through your brokerage.
J.R.Whalen: Why would somebody take out a brokered CD?
Imani Moise: Because banks offered their best rates through brokerages. By going through brokerages, they did not have to change the rates that they were advertising to their own customers directly, but they could still attract more deposits as needed.
J.R.Whalen: How does the rate on callable CDs differ from regular CDs?
Imani Moise: On average, a non-callable CD will be about 40 basis points lower than a callable CD, and that's because the bank is compensating you for taking that risk that they might call it back if rates fall.
J.R.Whalen: Why are banks calling the CDs now?
Imani Moise: It'll save them money in the long run. So when people purchase CDs, they're locking in a rate for a term. That could be one year, that could be five years. But if rates fall, that means that banks are stuck paying you that higher rate when they could just refinance it and get that money for cheaper.
J.R.Whalen: Is this happening to all callable CDs at once?
Imani Moise: No, it's at every bank's discretion. They may call some CDs and not others. They may be waiting for the market to fall a little bit more, but really the only way to know is to keep track of your brokerage account.
J.R.Whalen: If somebody purchases a five-year callable CD, can the bank call that before the maturity date?
Imani Moise: Yes.
J.R.Whalen: So that's not a binding contract.
Imani Moise: No. What you're buying, you're buying that rate, but you're also giving the bank the option or the right to take it back.
J.R.Whalen: How do you know that right exists?
Imani Moise: It's usually listed upfront. For example, I was looking at one of the brokerages, Fidelity's platform, and it has the list of all the CDs. It'll show you the yield, it'll show you the term, and then there's a column that says callable, not callable. Or call protected, yes or no. If it says yes, that means it's a non-callable CD. And you're locked in, you're truly locked in for that entire term. But if there's no call protection, that means you're running this risk.
J.R.Whalen: If a bank calls the CD before it matures, where does the invested money go?
Imani Moise: That depends on the brokerages and the default settings that you have. Most of the advisors that I spoke to suggested that you, one, check your default settings, and two, if possible, see if you could make sure that the proceeds are deposited in something like a money market account, which can still offer some yield.
J.R.Whalen: If someone is just now listening to us and realizing, "Hey, I've got a callable CD," what do financial analysts suggest that they do?
Imani Moise: The first thing is to go back and make sure that you fully understand the terms of your CD. So if it's callable, that means that there'll be a call protection period. That's usually about six months to a year. And once that period ends, that means the bank has the right to call your CD. Now, there's also call dates. Some CDs are continuously callable after the call protection period, meaning that they can be called back on any day, and some can only be called on certain days, maybe one day a quarter or something like that. So make sure that you understand the terms, and be able to keep an eye out for those key dates so you know when you need to reevaluate your options.
J.R.Whalen: So with this risk involved, why would somebody invest in a callable CD?
Imani Moise: To get those higher yields. As a matter of fact, some investors may be so excited when they saw a year ago these 5% cash returns, that they didn't check that call protection column or wherever those terms may have been listed. But that doesn't mean that callable CDs are always a bad idea. Some of the advisors that I spoke to said they can be part of a good investment strategy as long as you hedge your bets. And that means buying some non-callable CDs along with your callable ones.
