What is a Term Deposit?

Published by Thomas Herold in Banking, Investments, Laws & Regulations

'Term Deposit' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Term Deposit refers to a special type of deposit which individuals or businesses maintain at a bank or other financial institution. These are unique from standard deposits in that they include a fixed term. Such terms are usually shorter-term in nature. Their maturities could vary from a single month to several years or even five years. Term deposits are purchased. The lender is the customer, who makes a loan to the bank. The money is only allowed to be pulled back out once the term has concluded. Some contracts will allow an individual to provide a pre-set amount of days in notice if they need to withdraw the money early. Such kinds of financial instrument products are available at credit unions, thrift institutions, and commercial banks.

There are several other designations by which these term deposits go. They can be called bonds, time deposits, and certificates of deposit as well. Britain calls them bonds. Such deposits (by whatever name they go) represent an incredibly safe form of investment. This is why risk-averse and conservative investors find them appealing. Besides the bank backing up these terms and investments, The National Credit Union Administration and the Federal Deposit Insurance Corporation jointly insure them and backstop them against any losses to principal. Banks like them because the guaranteed amount of time they have to utilize the funds means that they can invest the money in financial products which feature larger gains.

The tradeoff for this is that the financial institutions themselves will have to offer a larger interest rate to the customer lender. The majority of banks will provide only fixed rates, yet this does not mean that variable rate CDs do not exist. In the early years of the 2000’s, banks sold CDs whose interest rates could be single-time bumped up but not lowered. The interest rates usually correspond to the amount of time existing in the time deposit.

For example, with a term deposit that has three years on it, the rate will be considerably higher than one that is only a three month term product. Similarly, larger CD amounts will receive higher interest rates. Jumbo CDs are those that come in increments starting at $100,000. They obtain much greater interest rates than do $1,000 amount certificates of deposit. Smaller institutions also tend to pay higher interest rates as well. Uninsured banks will provide the very largest interest rates on the products available.

The irony to these financial products lies in their name. Certificates of deposit imply that an investor will actually obtain a certificate on the terms of the deal. Usually this is not the case though. Originally, banks would deliver a type of certificate to the holder, but nowadays they are mere book entries on a bank statement. It is still possible to demand a paper statement that details the interest rate, principal, and amount of time remaining on the CD. These terms were mutually agreed upon by the financial institution and the customer lender after all.

There are penalties for those who decide to close out their term deposit before the time has fully elapsed. Breaking the maturity includes a loss of interest on principal. The penalties for early withdrawal are clearly marked on the documentation at the opening of a term deposit. This is required by congressional act according to the Truth in Savings Regulation. There are times however when interest rates have increased dramatically enough that the financial institution’s penalties may not deter the individual investor from withdrawing their CD to open a new one at the significantly higher rate elsewhere.

As the maturity date of the CD approaches, the bank will commonly dispatch a letter requesting direction from the customer lender. The investor may pull out the original principal plus interest completely penalty free at this point. They could also allow the instrument to roll over. When the owners do not provide any response and instructions, the financial institution has the right to simply roll it over automatically and reinvest the principal as they see fit.

Free Download (No Signup Required) - The 100 Most Important Financial Terms You Should Know!
This practical financial dictionary helps you understand and comprehend the 100 most important financial terms.

The term 'Term Deposit' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.