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Be CD savvy or be sorry
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November 1, 2000: 11:11 a.m. ET
Know the different risks of CDs sold at a bank and those sold by brokerages
By Laura Bruce
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NEW YORK (Bankrate) - Calling all CD savers!
As the stock market continues to scare the heck out of investors, more money is being pumped in certificates of deposit -- and they're safe and sound earners if you're aware of a couple of quirks.
If you buy a CD at a bank and patiently wait for it to mature, you'll see every penny of your principal and interest. But if you buy a CD at a brokerage, be on the alert for some differences.
 Often, CDs sold by brokerages are callable. You'll earn more than the going rate because you are essentially taking a risk -- but if you're not aware of how callables work you could lose if rates fall, or even if they rise.
The bank that issues the CD to the brokerage can pay you off after a specific period of time, usually one year (only the institution that issues the CD can call it).
Rate risk
Suppose you bought a two-year CD at 6.5 percent and the bank decided to call it after one year. You'd just get one year's interest. Banks would do this if interest rates had dropped. If you wanted to reinvest your money in another CD after the first one was called, you'd have to settle for the prevailing rate, which would be less than 6.5 percent.
"People are lured into callables because they have higher interest rates," says Bankrate financial analyst Greg McBride. "But the downside is that you may have to reinvest at a lower rate if they are called."
In addition to the callable feature, the reason CDs sold through brokerages generally have higher interest rates is because brokerages buy them in huge chunks from banks and then divvy them up to sell to you and me.
"But I thought..."
Another potentially nasty problem with callables has nothing to do with rates and everything to do with a simple, but common, misunderstanding.
State and federal regulators, such as the Securities and Exchange Commission, say they're getting complaints from investors who are confusing the callable date with the maturity date. Investigators are looking into whether people are being misled by some brokers into thinking "callable -- one year" means the CD matures in one year and that's when they can get their money back.
McBride says this misunderstanding can be a costly mistake if you have to ask the broker to sell the CD, especially if CD rates are higher.
"The date you think it matures comes and goes. Nothing happens. But you expected -- and you need -- the money. The CD hasn't matured so if you sell it you run the risk of losing not only some of the interest you've earned, but some of your principal as well.
"If the rates on CDs have risen, your CD will go up for sale with a lower rate of earning than buyers can get elsewhere. In this case the value of your CD is going to plunge because the only likely buyer of a 6.5 percent CD won't want to pay full face value on it.
"And FDIC insurance won't cover you," says McBride.
Watch your FDIC insurance limit
There's one other potential problem to keep in mind and if you overlook this one the risk can be substantial.
In addition to knowing the maturity date and whether a CD is callable, know what institution issued the CD. McBride says this is especially important if you have the $100,000 FDIC limit in a particular bank. If the CD is bought at a brokerage but your bank issued it, it will put you over the insurable limit.
And there are still a few more general cautions to keep in mind.
Check the reputation of the broker. Brokers that sell CDs have to register with the FDIC but the FDIC says consumers shouldn't take that as an endorsement of the broker. The SEC will have a record of any complaints or legal actions that have been filed against a broker.
Find out if there's an early withdrawal penalty for cashing a CD before maturity. Some brokers advertise that there is no early withdrawal penalty but don't expect to get all your money back - you'll only get what the broker can resell that CD for and it may be significantly less than what you paid.
Know whether the interest rate is fixed or variable and how the interest is paid. Do you have the option of being paid directly by check -- and how often -- quarterly, semi-annually or annually? Or is the interest rolled into the CD?
Get everything in writing and don't sign anything or pay any money until you have all the answers you need. 
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