I’ve been building CD ladders in my IRA and taxable savings accounts now that yields are so high. My IRA ladder extends to five years with a yield higher than 5%. However, I’ve been wondering if the longer term CDs will end up being called in if interest rates drop, and how quickly. It’s been so long since yields on cash were this high that I have no frame of reference. Does anyone recall past circumstances when CD yields were high and then dropped? I’m perfectly happy earning a 5% yield and will reinvest maturing CDs if yields stay high, particularly after the bond fund fiasco of the past year or so.
Comments
That article also states that callable CDs are not limited to brokered CDs. Banks can directly issue callable CDs.
To get an idea of when calls on IOUs are exercised by debtors (such as banks issuing CDs), one can look at callable bonds and at mortgages (where the debtor has the option of prepaying/refinancing, continuously).
One expects bonds to get called if they are trading at a premium, i.e. if they are paying above market rates. Bonds purchased at a premium don't always get called, though, for a couple of reasons.
One is that by the time the call can be exercised, market rates have risen to meet or exceed the bond coupon rate. You seem satisfied with the 5+% you're getting, so in the "worst" case, that's what you'll be stuck with if rates rise rather than fall.
Another reason that premium bonds don't get called is that the issuing institution runs into problems. The institution may have difficulty raising cash to pay off the bond (i.e. it can't refinance at a lower rate).
If a bank gets into trouble, it too may have difficulty raising cash, even when offering above market-rate FDIC-insured CDs. So there are some unusual circumstances when a bank might be slow in calling a CD paying above market rates. (But if it is taken over by the FDIC, the higher CD rate is likely to be terminated anyway.)
Next, mortgages. Anyone who has held a mortgage during a period of declining rates has likely looked into refinancing at the lower rate. Since there's overhead involved (documentation fees, possible points, etc.) one doesn't refinance every time rates drop a few basis points.
And if rates are dropping quickly, one may hold off a bit rather than refinance and then refinance again. By waiting a little longer (and paying the old, higher rate in the interim) one saves costs by refinancing fewer times.
So speed of rate decline is a consideration, and one that I suspect banks look at as well in deciding when to call a CD.
When all is said and done, I expect the late 1990s experience described in the Chicago Tribune to be representative. Many banks will call CDs as soon as they're able, so long as the CDs are paying above market rates for their remaining terms.
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To the OP, pretty sure you should expect the majority, if not all of your longer-term, callable CDs to be called in the coming months/years. Just as we were reasonably certain that interest rates would rise this year, I at least am reasonably certain that interest rates will start decreasing in the near future. And, the difference between callable and non-callable is generally not greater than 0.5%.
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On the issue of buying only shorter term CDs of say 2 years...Well, that is, how shall I say, short-sighted, and those investors who want to replace their maturing CDs in 2 years are likely going to be feeling a wee bit of buyer's regret.
Example using current listing of Fido CDs:
You are looking at CDs today. You only want non-callable CDs and you only want to go out a max of 2 years. So you buy the best 2-yr, non-callable CD that Fido has to offer at 4.95%.
In two years it matures and you are looking for another 2-yr, non-callable CD to replace it. In 2 years, you will need to find a 2-yr, 4.25%, non-callable CD to equal the same rate that you could have had in hand IF you had bought today's best 4-yr, non-callable CD at 4.60%.
Good luck with that. I'm reasonably certain that 2-yr, 4.25%, non-callable CDs will NOT be available in May 2025.
Always best to put together an EXCEL spreadsheet and drop in the rates that are available NOW for respective periods, and determine what rate you will need upon maturing of a shorter-term CD (2 yrs in this example) to meet or exceed the rate of the currently available longer-term CD (4 yrs in this example).
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Disclaimer_2: Future interest rates are usually WAGs.
BUT, in the last say 6-12 months, it was something short of that as we were reasonably certain they were going UP, and we could even reasonably project where they would peak.
Likewise, at this point, I at least am reasonably certain that rates will start going DOWN in the near future, but not anywhere near as capable of projecting how low they might go.
So, my money, in this example, is on buying the 4-yr, 4.60% non-callable CD today as I have little-to-no expectation that a 2-yr, 4.25% non-callable CD will be available in May 2025.
EDIT: The other argument against buying shorter term CDs, e.g., a current 1-yr, 5.15%, non-callable, is that the best money market funds are paying about the same, with VMRXX currently at 5.03% and FZDXX currently at 4.88%.
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And speaking of potential buyer's regret, recall that 4-yr, 5+%, non-callable CDs were widely available for a brief period not so long ago. Here's hoping that many here participated when we hit peak rates AND thought long-term!
YMMV.