A time deposit is an interest-bearing bank account that has a pre-set date of maturity. A certificate of deposit (CD) is the best-known example. The money must remain in the account for the fixed term in order to earn the stated interest rate.
Time deposits generally pay a slightly higher rate of interest than regular savings accounts. The longer the time to maturity, the higher the interest payment will be.
Another name for this type of investment is term deposit.
Time Deposits Explained
A time deposit, such as a CD, can be purchased at virtually any bank, credit union, or other financial institution. Interest rates and other terms vary. For example, one bank may offer a higher return but require a larger deposit.
It pays to shop around. Most post their rates prominently and advertise them widely.
A CD is essentially a savings account that is opened with the promise that the owner won’t touch the money for a set period of time. This can range from a few months to years. A term of a year or less is considered a short-term time deposit. Anything over that is a long-term deposit.
Penalties on Early Withdrawals
The owner of a time deposit can withdraw the money if necessary but will lose some or all of the promised interest and may pay penalty fees. The terms are in the fine print given when opening the account.
A customer can earn a slightly higher interest rate with a time deposit account compared to a standard savings account or an interest-bearing checking account because the funds remain locked until the maturity date of the account.
Time deposits are insured up to $250,000 per investment. Those opened at a credit union carry similar protection from the National Credit Union Administration (NCUA).
Key Takeaways
- Time deposits, like CDs, are interest-bearing bank accounts with a set maturity date.
- Funds in a time deposit must be held for the fixed term to receive full interest.
- Typically, longer terms result in higher interest rates for depositors.
- While extremely safe, time deposits generally offer a lower rate of return.
Why Banks Offer Time Deposit Accounts
Time deposit accounts provide banks with the cash flow necessary to lend money to other customers. The bank profits by lending funds at a higher interest rate than it pays on time deposits.
Banks may also invest the money from time deposits in other securities that offer a higher return.
Some Options on Time Deposits
Banks and other financial institutions may accept any maturity term a customer requests, as long as it is a minimum of 30 days.
Once the investment matures, funds can be withdrawn without penalty, or the investor may choose to renew the time deposit account for another term, such as rolling over a one-year CD into another one-year CD.
Longer Terms Earn Higher Interest
Typically, the longer the term to maturity, the higher the interest rate paid to the depositor. For example, a one-year CD may offer a 1.10% annual percentage yield (APY), while a five-year CD for the same amount might provide a 1.75% APY. The APY is the effective annual rate of return accounting for compounding interest.
Interest Rates and APY
There are usually two rates quoted for time deposits and CDs:
- The interest rate is the percentage interest that the customer would earn if the interest amount is withdrawn each month.
- The annual percentage yield (APY) is the amount the customer will earn if the interest is allowed to remain in the account and compound.
The APY, therefore, is higher than the quoted interest rate.
The Downside of Time Deposits
As with most financial products, there are advantages and disadvantages to time deposit accounts. They are a safe place to put your money and are easy to obtain. Like other bank deposits, time deposits are insured against losses.
However, the rate of return is usually lower compared to other investments. An investor could possibly earn a higher yield by depositing money in bond mutual funds or Treasury bills.
There is also another risk, especially with long-term deposits. Interest rates may increase over time, while the investor’s money is locked into the lower rate that prevailed when the account was opened. Higher interest rates often accompany higher inflation, reducing the real spending power of the money.
Pros
- Time deposits offer a fixed interest rate until maturity.
- They are risk-free investments backed by insurance.
- Various maturity dates and minimum deposit amounts are available.
- Higher interest rates than regular savings accounts.
Cons
- Returns are lower compared to other conservative investments.
- Opportunity cost if interest rates rise.
- Penalties for early withdrawal.
- Fixed interest rates may not keep up with inflation.
Real-World Examples of Time Deposits
A look at some examples of time deposit returns offers insight into the variations among CDs at financial institutions:
- American Express: APY of 0.55% for one year, 2.05% for three years, or 2.15% for five years. No minimum deposit.
- Comenity Direct: 2.10% APY for one year, 2.20% for three years, and 2.20% for five years. Minimum $1,500 deposit.
- Synchrony Bank: 2.00% APY for one year, 2.10% for three years, and 2.15% for five years. Minimum deposit of $2,000.
Related Terms: certificate of deposit, savings account, interest-bearing, financial institution.
