If you’ve been searching for higher investment yields lately, you may have encountered certificate of deposit offerings from a securities broker or financial advisor. These certificates are commonly referred to as brokered certificates of deposit.
A brokered certificate of deposit differs from CDs offered directly by banks in at least two material respects. And while not all of these CDs are inherently bad, some can have negative outcomes depending on the fine details.
Here’s what to look out for:
First, funds invested into a brokered certificate of deposit cannot be withdrawn before maturity. If an investor needs their money back early, they can only get it by selling the certificate back to their broker.
The price you receive may be more or less than the amount invested, depending on market conditions and the selling fee charged by the broker (if any).
Second, some brokered CDs have a feature that allows the issuing bank to pay the investor back early at the issuing bank’s option; this is commonly referred to as a call option.
A call option would normally occur after a period of declining interest rates because it would allow the issuing bank to pay back higher interest rate certificates and then issue new ones at lower rates.
Of course, this means that the investor would be forced to reinvest their returned funds at lower rates as well.
When you invest in a longer-term certificate of deposit, you are likely doing so to lock in an attractive interest rate for the entire term of the certificate. However, you might get a nasty surprise if you purchase a brokered certificate of deposit with a call option in its terms.
While there are still benefits to purchasing brokered CDs, it’s important to carefully review and understand the terms and conditions before investing.
This is the only way to ensure that you don’t get burned by one — because when it comes to a brokered certificate of deposit, the devil is in the details.