CD savers face a difficult call

Today's certificates of deposit come in a variety of rates, lengths, and minimum deposits. But lately, a growing number have taken a new form.

Callable CDs are debt instruments that pay a a premium over regular CD yields for a specific period (say, five years). But there's a catch: They can be called (redeemed) by the issuer, usually after one year.

Callable CDs, like all bank CD products, are insured up to $100,000 by the FDIC. Yields can be very attractive. For example, Providian Bank in San Francisco offers a five-year callable CD yielding 6.5 percent. It requires a $10,000 minimum investment and can be called by Providian after a year.

Always read the fine print with callable CDs, warns Greg McBride, a financial analyst with information website Bankrate.com. After the initial noncallable period, he says callable CDs may be subject to continuous recall (whenever the issuer wishes), or periodic recall on specified call dates.

The jury is still out on these instruments, which date back to the mid-1990s. But many financial consultants are wary of the product, and some are downright adamant against them.

Why? Because in today's declining-interest-rate environment, there is very definite "reinvestment risk," says Mr. McBride. If you have a callable CD yielding 7 percent, for example, you might have to reinvest at 6 percent or less in just a year, he notes.

Moreover, in a rising-interest-rate environment, you may miss out on the opportunity to lock in a higher rate. If you sell a callable CD early, penalties could make it worth less than when you bought it.

Still, some financial advisers believe that once investors learn more about callable CDs, they will find them attractive.

"The bond market - certainly the municipal bond market - is based on the concept of call provisions," says Ray Julian, a financial adviser and host of the Boston radio show "Today's Millionaire" on WBNW. Now, "banks are repackaging debt" in a similar way, he says.

Callable CDs are sold by individual banks, as well as through brokerage houses. If you buy through a broker, you have to be especially attentive to the call date (which is often confused with the maturity date of the CD), as well as the identity of the institution selling the CD. If it is a bank where you already have accounts, you could find the limits on your FDIC insurance (at $100,000 per account holder ) compromised.

Banks that have offered callable CDs include LaSalle Bank, Chicago; MidFirst Bank, Oklahoma City; Providian, San Francisco; First Union, Charlotte, N.C.; and Bank Illinois, Champaign, Ill.

Whether or not you choose to buy a callable CD, "this is probably the moment to lock in a CD," says McBride.

Long-term interest rates have been gradually easing since last September. But when the Federal Reserve slashed a key rate by one-half a percentage point earlier this month, rates began a downward tumble.

Some 60 percent of all financial institutions lowered rates on CDs in the week ending Jan. 12, McBride says. Yields are now generally down a quarter of a percentage point across the board.

While yields have solidified in recent days, the prospect is for continued erosion at the longer end of the investment horizon, say one to two years or more, says McBride. That is especially likely if the Fed makes further rate cuts.

McBride, who is one of a small coterie of financial analysts who spends hours tracking the merits and demerits of CDs, believes that investors should shy away from short-term CDs, given the reinvestment risk. But locking in at two years or more helps you "alleviate" that risk, he says.

Currently, one-year CDs yield an average of about 5 percent; yields for 5-year CDs are running about 5.2 percent. (See chart above.)

Best CD Buys

SIX-MONTH CD

Institution Phone number % yield deposit minimum deposit

Chattahoochee Natl 877-881-2621 6.52% $1,000

DeepGreen Bank 888-576-9238 6.40 $1,000

Umbrellabank.com 888-280-1990 6.40 $1,000

IndyMac Bank, FSB 800-734-6063 6.30 $10,000

giantbank.com 877-446-4200 6.26 $2,500

ONE-YEAR CD

Security First Ntwk Bk 800-736-2321 6.60 $1,500

Central State Bk 205-668-0711 6.50 $500

Chattahoochee Natl 877-881-2621 6.50 $1,000

Imperial Capital Bk 800-455-4485 6.50 $2,000

Flagstar Bank, FSB 800-642-0039 6.50 5,000

FIVE-YEAR CD

Provident Bank 800-335-2220 7.05 $1,000

Intervest Natl Bk 212-218-8383 6.80 $2,500

Flagstar Bank, FSB 800-642-0039 6.80 $5,000

Principal Bank 800-672-3343 6.64 $1,000

Capital One FSB 800-564-7426 6.60 $10,000

(c) Copyright 2001. The Christian Science Publishing Society