What Is a Time Deposit

A time deposit is an interest-bearing bank deposit account that has a specified date of maturity, such as a certificate of deposit (CD). The deposited funds in time deposits must be held for the fixed term in order to receive the interest rate paid.

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Time Deposits

Time Deposit Explained

A time deposit allows a customer to potentially earn a higher interest rate than a standard savings account. The customer is paid the higher rate because the funds are locked up until the maturity date of the time deposit. A CD or certificate of deposit is a type of time deposit whereby maturity dates can be from 30 days to up to five years.

Although funds can be withdrawn from CDs without notice, there are penalties for early withdrawal, which could include a fee or the customer might lose the interest earned up to that moment. Different banks might have specific conditions surrounding the ability to withdraw the funds, including the use of penalties for when the depositor makes an early withdrawal. It is due to this sacrifice of liquidity that banks offer higher interest rates compared to most basic savings accounts.

Like CDs, time deposits are sold by banks and credit unions. Time deposits are insured by the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA) for credit unions.

Why Banks Offer Time Deposit Accounts

Time deposit accounts provide banks the funds necessary to lend money to other individuals or companies. The bank makes a profit by lending the money held in the time deposit account for a higher interest rate than the rate paid on the time deposit. The bank can also invest the money from the time deposit in other financial securities that pay a higher return than what the bank is paying the customer.

Maturity and Interest Rates

Banks and other financial institutions can negotiate any maturity term (the length of the deposit) that a customer requests, as long as the term is a minimum of 30 days. Once maturity is reached, the funds can be withdrawn without penalty, or the account can be renewed for another term. For example, a one-year CD would mature and roll into another one-year CD if the customer did not want to withdraw the funds.

Typically, the longer the term, the higher the interest rate that's paid to the depositor. For example, a one-year CD may offer a 1.10% APY, while a five-year CD for the same amount might provide a 1.75% APY.

The APY stands for the annual percentage yield (APY), which is the effective annual rate of return taking into account the effect of compounding interest. There are two types of rates quoted for time deposits and CDs. The interest rate quoted on a CD is the rate that the customer would earn if the customer withdrew the interest amount earned each month, which some products offer that feature. However, if the customer wants the interest reinvested for the length of the maturity, the customer would earn the annual percentage yield quoted. As a result, the APY quoted by a bank is typically a higher rate than the interest rate quoted. CDs that have larger initial deposits are usually offered a higher rate than CDs with smaller deposits.

Key Takeaways

  • A time deposit is an interest-bearing bank deposit account that has a specified date of maturity, such as a certificate of deposit (CD).
  • The deposited funds in time deposits must be held for the fixed term in order to receive the interest rate paid.
  • Typically, the longer the term, the higher the interest rate that's paid to the depositor.

Real World Examples of Term Deposits

Citizens Bank (CFG) is a regional bank in the U.S. that offers several types of term deposits. Below are a few of the bank's CDs along with the interest rate paid to depositors.

  • A one-year CD pays 1.00% with a $1,000 deposit.
  • A two-year CD 1.75% with a $1,000 deposit.

We can compare the rates offered by Citizens Bank to the rates offered by Wells Fargo Bank (WFC), which is one of the largest consumer banks in the U.S. Below are a few of Wells Fargo's CD offerings along with the interest rates paid to depositors.

  • A one-year CD with a minimum $2,500 deposit pays 1.25%.
  • A special CD that requires a $5,000 minimum deposit pays 2.27% for 29 months.

We can see that a larger initial deposit and the length of maturity for the CDs can make a difference in the rates paid by the banks. Please note that the interest rates being offered for new CDs by the both banks can change at any time.