Understand the Various Types of CDs

Physician's Money Digest, February 2006, Volume 13, Issue 2

Certificates of deposit, commonly knownas CDs, come in three different types:callable, step-up, and bump-up. Accordingto Bankrate.com, if you plan to invest inCDs, it's important to know the differencesin them before you spend your money:

•Callable. A callable CD can be calledaway from an investor after the expirationof the call-protection period, but beforethe maturity of the CD. Callable CDs areoffered by banks to put interest rate riskon the depositor, thus giving the CD ahigher yield than a CD without a call provision.Interest rate risk means that if ratesgo higher, there is no gain for the investor,and if rates go lower, the CD can be calledaway by the bank. Therefore, it is a riskyoption that's not the most attractive.

•Step-up. Step-up CDs also have callprovisions, but if they aren't called away,the interest rate steps up to a higher rate.Step-ups are more desirable than callableCDs because they alleviate interest raterisk. However, they are not widely offered.

•Bump-up. Normally, bump-up CDsaren't callable. The depositor can increasethe yield at some point in the CD's life tocurrent market yields for that maturity. Thisallows the depositor to be more comfortablein investing in long-term CDs becausethey can receive higher yields if interestrates rise. Some banks require that theinvestor deposits additional money whenthey bump up the interest rate, and typicallythe yield can only be bumped up duringthe first half of a CD's life.