Why term deposit

The interest earned on a term deposit account is slightly higher than that paid on standard savings or interest-bearing checking accounts. The increased rate is because access to the money is limited for the timeframe of the term deposit.

Term deposits are an extremely safe investment and are therefore very appealing to conservative, low-risk investors. The financial instruments are sold by banks, thrift institutions, and credit unions. If a customer places money in a term deposit, the bank can invest the money in other financial products that pay a higher rate of return RoR than what the bank is paying the customer for the use of their funds.

The bank can also lend the money out to its other clients, thereby receiving a higher interest rate from the borrowers as compared to what the bank is paying in interest for the term deposit.

The spread between the rate the bank pays its customers for deposits and the rate it charges its borrowers is called net interest margin. Net interest margin is a profitability metric for banks. Banks are businesses, as such, they want to pay the lowest rate possible for term deposits and charge a much higher rate to borrowers for loans. This practice increases their margins or profitability.

However, there is a balance the bank needs to maintain. If it pays too little interest, it won't attract new investors into the term deposit accounts. Also, if they charge too high of a rate on loans, it won't attract new borrowers.

In periods of rising interest rates, consumers are more likely to purchase term deposits since the increased cost of borrowing makes savings more attractive. Also, with higher market interest rates, the financial institution will need to offer the investor a higher rate of interest, so the investor also earns more.

When interest rates decrease, consumers are encouraged to borrow and spend more, thereby stimulating the economy. In a low interest rate environment, demand for term deposits can decrease since investors can typically find alternative investment vehicles that pay a higher rate. Typically, interest rates should be proportional to the time until maturity, and the minimum amount of principal lent to the credit union or bank.

In other words, a six-month term deposit will likely pay a lower interest rate than a two-year term deposit. Investors not only receive a higher rate for locking up their money with the bank for extended periods, but also should earn a higher rate for large deposits.

Term deposits are also called certificates of deposits. Customers can view the conditions of the term deposit via a paper statement. This statement includes the required minimum principal amount, the interest rate paid, and the duration or time to maturity , as agreed by the bank and the depositor. If a customer wants to close a term deposit before the end of the term, or maturity, the customer will be subject to a penalty.

This penalty may include the loss of any interest paid on the deposit account until that point. Closing the CD before the term ends lets the customer take back the principal amount invested but with the forfeiture of the earned interest. The penalty for withdrawing prematurely or against the agreement is stated at the time of opening a term deposit, as required by the Truth in Savings Act.

Sometimes, if interest rates have risen considerably, it might be worth it for a customer to close the term deposit early, take the penalty for the early withdrawal, and reinvest the funds elsewhere at a higher rate. It's important to be sure that the alternative rate is high enough to more than compensate for the original rate on the term deposit plus the cost of the penalty. When a term deposit is nearing its maturity date, the bank holding the deposit will usually send a letter notifying the customer of the upcoming maturity.

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You decide how long you want to maintain the deposit. The conditions of a term deposit cannot be changed: as a product with a specific duration, banks cannot change any of the conditions agreed at the time of purchase. Term deposits are a good option for conservative investors who are reluctant to take risks and who want guarantees for their investments. When purchasing a term deposit, it's important to be clear that you won't need the money for the agreed period because if you withdraw it early, you will have to pay a penalty.

What are the advantages of investment funds compared to deposits? A term deposit gives you more interest rate security but a savings account is more flexible. A savings account is more accessible, but a term deposit could be the perfect product to help you resist impulse spending.

For a full comparison of the two account types, check out our dedicated guide to term deposits vs savings accounts. First, head over to our term deposit comparison page to find the best offers from across the market. Next, narrow it down with our term deposit search tool , which will show you results applicable to your deposit amount and desired term. Competitive rates and fast online application for one year term deposit. No account keeping or set up fees to pay.

Option to have interest paid at maturity. Interest paid monthly, quarterly, half yearly or yearly Terms and Conditions apply. Interest rate depends on balance amount. Optional 3,6,9 or 12 month terms. Mozo provides general product information.

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