Time Deposit Meaning
Time deposit, also known as term deposit, refers to the deposit account with fixed maturity and interest rate. It usually prevents the premature withdrawal of the deposit. Certificate of deposit (CD) is one of the common examples.
Early withdrawal penalty applies to those who withdraw the deposit before reaching the maturity date. Usually, the penalty will be a fixed percentage of interest earned. The interest rate associated with the term deposits may increase with an increase in tenure. In addition, the interest rate will be comparatively higher than the one offered by standard savings accounts.
Table of contents
- A time deposit is a bank deposit where funds are invested at a fixed interest rate for a specific period.
- Two common types of time deposits are fixed deposits and recurring deposits.
- Fixed deposits require a lump sum amount to be invested at the beginning of the term, while recurring deposits allow for regular, smaller contributions to be made.
- Time deposits are a low-risk investment option offering higher interest rates than savings accounts but may have penalties for early withdrawal.
How Does Time Deposit Work?
A time deposit or term deposit is an example of a low-risk investment. Customers choosing a term deposit account places a fixed amount of money for a specified period into the account. As per norms, the deposit is non-withdrawable until it reaches maturity, and early withdrawal is liable to a penalty. The customer receives principal and interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. at maturity. In some cases, the interest is distributed periodically, like monthly, quarterly, or yearly.
Providing term investment schemes helps banks in many ways. For instance, it increases the cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. , and banks can offer loans utilizing the deposits. In addition, while banks use the deposits for various purposes during the maturity period, customers cannot access their deposits. However, customers benefit from interest income, which is often more significant than the interest income derived from a standard savings account. This way, both customers and banks are reaping the benefits.
The time deposit interest rate may vary depending on the attributes like bank, maturity period and the amount invested. Also, interest rate even varies within the banks between the accounts. However, comparing the interest rates of different investment options, it is evident that term deposit offers a higher interest rate compared to certain savings accounts and lower rates than securities like bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period..
Types of Time Deposit
People can avail the service of term deposits from financial institutions like banks and credit unions. The term used to indicate this may vary between financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. . Certificate of DepositCertificate Of DepositA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period. (CD), term deposit, or fixed deposit are commonly used words. Furthermore, post offices provide investment instruments like Post Office Time Deposit Schemes in certain countries.
#1 – Fixed deposit
A fixed deposit scheme requires a single large amount to account for a fixed tenure. The customer cannot access the fixed deposit without completing the maturity period. Therefore, they are non-checkable deposits, non-negotiable, and non-payable on demand. If the interest earned is accessible only after maturity, it is known as a reinvestment deposit.
#2 – Recurring deposit
A recurring deposit account provides the customer with the provision to deposit a fixed amount in regular intervals spanning the maturity period. For instance, a predefined amount is deposited monthly for a long period.
Term deposits are also classified based on the maturity period. Short-term deposit maturity ranges from one to twelve months, and long-term deposit tenure will be one to ten years.
Time Deposit – Practical Example
The following example explains the concept of interest accumulation and the early withdrawal penalty. Account-holders usually use time deposit calculators for analyzing accurate details of interest rates or maturity amounts.
Peter wants to open term deposit accounts in a bank. Peter is looking for a long-term investment. He purchases a CD worth $3,000 with a fixed interest of 4%. The maturity of the investment is five years.
After the first year, he would have earned $3,120. Then, 3,244.80 in the second year, $3,374.59 in the third, $3,509.57 in the fourth, and finally $3,649.95 at the end of the process. Thus, by the end of the maturity period, he would have over 20% more money than he had at first.
However, if he wishes to withdraw the money before completing the maturity period, for instance, by the end of the first year of the investment, he will need to pay a fine of 12 months interest. So if he gets his money at the end of the first year, for example, he’ll only receive $3,000 instead of $3,120.
Time Deposit vs. Fixed Deposit
Some people may feel difficulty determining the differences between a time deposit and a fixed deposit. The critical problem is that it is difficult to discern between different attributes since they are essentially the same thing. In general, fixed deposits are a subset of term deposits.
Different parts of the world address the same concept with distinct names. For example, time or term deposits are used mainly in anglophone countries. On the other hand, in the United States, the term certificate of deposit is more common. Whereas, in Asian countries, such as India, fixed deposit is common usage.
A few financial institutions may differentiate between the two terms, but they will mostly follow the same guidelines with only a few differences, such as the contract’s maturity, for example.
Frequently Asked Questions (FAQs)
A demand deposit is a deposit account where the funds can be withdrawn anytime by the account holder without any prior notice or penalty. In contrast, a time deposit is a deposit account where the funds are held for a fixed term, typically ranging from a few months to several years. The account holder cannot withdraw the funds before the maturity date without incurring a penalty.
A 5-year time deposit is a type of deposit account where the deposited funds are held for a fixed term of 5 years, and the account holder earns interest on the deposit. The interest rate on a 5-year time deposit is typically higher than that of a shorter-term deposit, as the financial institution can use the deposited funds for a longer period.
Time deposits can be a good investment option for individuals who want to earn higher interest rates on their savings than they would through a regular savings account. However, it’s important to consider the length of the deposit term and potential penalties for early withdrawal before committing to a time deposit.
This has been a guide to Time Deposit and its Meaning. Here we discuss types of time deposit and how it works, along with an example and time deposit vs. fixed deposit. You can learn more from the following articles –