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A term deposit is also referred to as a time deposit, which is an investment instrument. The account holder deposits a specific amount of money at an agreed interest rate for a fixed timeframe. This type of deposit may range between 1 month and 5 years.
A time deposit is available at financial institutes such as NBFCs (Non-Banking Financial Companies), banks, post offices, building societies, and credit unions. Welcome to this post that enlightens you about the facts and facets related to term deposits.
What is Term Deposit?
Term deposit & its investments are all about depositing money into the account holder’s account at any financial institute, including banks, NBFCs, credit unions, post offices and building societies. This type of investment comprises short-term maturities and may have different levels of minimum deposits.
Investors can withdraw the funds only after the term closes. But if they give early notifications, time deposits are allowed for prior termination. But for early terminations, there are penalties involved.
Term Deposit Explained
Now that you know what is term deposit, here’s a comprehensive guide explaining term deposit point-wise:
● If an account holder deposits a lump sum of money at a bank, the bank uses that money to lend to a business or consumer.
● Since someone else is borrowing the money, they need to pay the depositor some compensation.
● This type of compensation is called interest on the depositor’s account balance.
● But most deposit accounts let the owner withdraw their money anytime.
● That makes the job of the bank difficult to assess how much they will lend at any point in time.
● The bank needs to overcome this type of issue. So, they provide customers with term deposit accounts.
● The customer deposits on this account and agrees that they won’t withdraw money from that account for a fixed time.
● In return, they get high interest on the account.
● The interest they earn is higher than the amount paid on the standard savings since access to this money is limited.
Characteristics of Term Deposits
In general, time deposits are a safe investment and are appealing to low-risk and conservative investors. Here’s a rundown of the overall characteristics of term deposits:
● Get a fixed interest rate: Time deposits comprise a fixed rate of interest, which would never be subject to fluctuations.
● Excellent investment period: Investors get the freedom to select the investment tenor depending on plans provided by the respective financial institution. The rate of interest offered by an institution is always higher for longer tenors. However, one should always compare interest to tenor ratios before investing the money in a time deposit.
● Extremely safe and secure: Term deposits comprise interest rates that stay unaffected by any alterations made in the economy. Thus, it is an extremely safe investment solution.
● A golden opportunity to generate wealth: Investing in it is the best way to generate wealth. Its stable interest in the investment ensures that an investor’s wealth grows during the most challenging times in the financial market.
● Premature withdrawal has some consequences: These deposits come with a fixed tenor, so it is considered locked-in. During this time, if the investor withdraws the money, they will be liable to pay a penalty amount to the bank or other financial institution. Also, they will get lowered interest income.
● An additional payment in the form of interest: An investor gets the opportunity to get the interest either periodically (yearly, monthly, or quarterly) or after maturity
● Rolling Over: Suppose you don’t need the money after your term deposit is matured. In such an instance, you can roll over your deposit for another fresh term. In simple words, rollover is nothing but reinvesting maturity proceeds in the new term deposit & adding that interest. An investor who does not want to utilize the money after the term deposit matures can choose the rollover option.
● Taxation on interest: Considering the Income Tax Act, an interest earned on a deposit happens to be taxable income. It might be subject to the Tax Deducted at a Source (TDS).
● Low investment limit: A lower investment limit varies according to the financial institution. However, the lower limit happens to be INR 1000. But note that there is no upper limit on the amount invested in the term deposits.
● Insurance on the deposit: Under RBI regulations, deposits in the bank will be eligible for the insurance cover of Rs 1 lakh under the DICGC or Deposit Insurance and Credit Guarantee Corporation.
● Loan against deposit: When an investor requires financial liquidity in a contingent scenario, they may avail of the loan of 60-75% of the overall deposit amount.
Types of Term Deposit
Term deposits are divided into the following types:
● Sweep-in facility: Financial institutes provide account holders with the sweep-in feature. This feature allows every individual to set an upper limit on savings accounts. The amount that’s higher than the limit might be converted into a term deposit. If a savings account has deficits, the funds might be withdrawn from term deposits with the loss of interest on funds that are swept in. The best part of investing money in the sweep-in- deposit is that it offers a high-interest rate.
● Long-Term & Short-Term Deposits: These term deposits are categorized depending on the investment’s holding period. The short-term deposit comprises a lock-in period that ranges from 1-12 months. These deposits are perfect for investors who look for quick returns. On the other hand, long-term deposits consist of a lock-in period that ranges between 1 and 10 years. Such deposits offer a higher rate of interest when compared to short-term deposits.
● Senior citizen deposits: Someone who wants to invest in the term deposit and is above 60 years of age can consider senior citizen time deposits. A majority of financial institutes or banks offer a higher rate of interest on term deposits for seniors. They can get tax-saving term deposits at some financial institutes, including banks.
● Cumulative & non-cumulative: Investors who do not require regular financial income from their deposit can consider investing in the cumulative term deposit. Their rate of interest earned will be reinvested into their deposit. The amount will be paid as a lump sum at the tenor’s end. On the contrary, a non-cumulative term deposit can be considered by an investor who needs regular interest payout. Here, the interest gets credited to that investor’s account yearly, quarterly or monthly.
● Tax-saver deposits: This type of deposit is eligible for a tax deduction of Rs. 1.5 lakh (Income Tax Act’s Section 80C). The tax-saver deposits comprise a lock-in period of five years. Any income that ranges above INR 40,000 happens to be taxable. And the interest rates may vary from 5.5% to 7.75%.
● Post Office Deposit: Next comes the post office tax deposits. Even post offices offer financial services. It might be opened as a joint account or individual. Account holders may transfer the post-deposit accounts from the post office to another account. The account holder can have multiple accounts in one post office. Considering the minimum limit for deposits, the amount is Rs.200. The interest rate is 7.5% for five years. Any deposit for the tenor longer than five years will be eligible for tax benefits under Section Income Tax Act’s 80C (1961).
● Special deposit schemes for children: A few special deposit schemes are aimed at the welfare of children. One of them is the Sukanya Samriddhi Account which visions to improve the financial stability of a girl child above 10 years of age. But these types of schemes vary from one bank to another (and one financial institution to another).
How a Bank Uses a Term Deposit
If an account holder invests money in a time deposit, a bank may invest it in financial products with a higher RoR (rate of return) compared to the amount it pays customers for using funds. The bank may lend money to other clients (businesses or individuals) to receive a high-interest rate. They charge a higher rate from borrowers and pay a certain amount of the profit to the term deposit account holder.
Term Deposits and Interest Rates
The interest rates are already rising, and consumers tend to buy term deposits since the increased borrowing cost makes savings more intriguing. If interest rates tend to decrease, consumers borrow & spend more. But with a low-interest rate, term deposits’ demand may decrease.
So, interest rates must be proportional to the time until the date of maturity. So, a term deposit of six months may have a lower rate of interest when compared to a time deposit of two tears. So, investors can get a high rate for locking up the money with the financial institute for a long time period. Besides, they earn a high rate for their large deposits too.
Opening or Closing a Term Deposit
A time deposit or term deposit is also known as the certificate of deposit (CD). Customers may view the term deposit’s conditions through the statement. The paper statement comprises the following details:
● The total interest rate paid
● Minimum principal amount
● Time for maturity
These should be agreed upon by a depositor or bank.
Closing the deposit before the maturity date results in a penalty. The penalty might include loss of interest paid on a deposit account. Closing the term deposit before the end of the term allows the customer to get back their principal amount with the earned interest’s forfeiture.
If the interest rates rise, a customer may close the deposit before maturity and take the penalty. Later on, they can reinvest the funds somewhere else at a higher rate of interest.
If the term deposit is nearing its maturity date, a bank holding that deposit sends a letter to notify the customer about the forthcoming maturity.
The bank asks whether the customer wants that deposit renewed for the same maturity length. In terms of the rollover, the amount will be at a different rate depending on the market interest rate. The customer may place their fund in a different financial product too.
Inflation and Term Deposits
The inflation rate is how much the price rises in a given fiscal year. When the rate on the term deposit is 2%, and the inflation rate is 2.5%, a customer does not earn enough to compensate for the price increase. Sadly, the term deposits don’t keep up with inflation.
Example of Term Deposits
Suppose you want to invest Rs. 25,000 for a total of three years at a 7.1% annual rate of interest. In such a scenario, a cumulative TD will have a maturity value of Rs. 30,712.
How Can a Depositor Benefit from a Term Deposit?
A depositor might make their deposit in a TD account. But they must first agree on not withdrawing their funds for a certain period in return for the higher interest on the account.
Fixed Deposit vs Term Deposit
A TD is used when a deposit is extended for a particular period (3 or 6 months or more). But a fixed deposit is used when a deposit is for 6 months or greater. A deposit amount provides a high RoR. In both these investments, an investor deposits a sum of money for a certain period to earn the interest.
Other than that, both the term deposit and fixed deposit investments are almost similar, considering the penalty, security, and opening of the accounts.
How To Invest In a Term Deposit?
You may open a term deposit account with a low minimum amount (it might be Rs. 100). In general, banks usually don’t set any maximum amount for investments. You can obtain a high rate of interest on the term deposit account once you opt for longer investment tenures.
So, now, you have learned everything about term deposit meaning, significance, characteristics, types, and examples. After elucidating these pointers, let’s now answer the most common questions usually asked by customers before their investments.
Term deposit & its investments are all about depositing money into the account holder’s account at any financial institute, including banks, NBFCs, credit unions, post offices and building...
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Frequently Asked Questions
Banks will allow customers to withdraw a fixed deposit amount upon maturity or during the premature stage. But partial withdrawal before its maturity isn’t allowed when the account is the Tax Saver or Non-Withdrawable fixed deposit. A majority of banks have a lock-in period comprising five years for the tax saver fixed deposit.
In fixed deposits, the interest rate is higher. But the most significant benefit of choosing the savings account over the term deposit is the ability to access the savings while earning interest. But an account holder has an instant to withdraw the money, unlike the term deposit. So, a TD is always better than a savings account.
A short-term deposit consists of a lock-in period ranging from 1 and 12 months. But a long-term deposit has a lock-in period ranging from 1 to 10 years. A short-term deposit offers quick returns, whereas a long-term deposit has a higher rate of interest.
A term deposit is used when a deposit is extended for 3 months or more. But fixed deposits are used if the deposit is for a minimum of 6 months. Other than that, they are almost the same considering penalties, security, and more.