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 must remain in the account for the fixed term to receive the stated interest rate. Time deposits are an alternative to the standard savings account, and will usually pay a higher rate of interest.

Other names for this type of investment include term deposit.

Certificates of deposit are types of savings accounts or negotiable instruments whereby the customer is paid interest in exchange for depositing funds into the account for a set period of time. CDs are issued by banks, credit unions, and other financial institutions. There are many different types of CDs with varying terms of maturity and minimum investment requirements. Those requiring a larger initial deposit usually offer a higher return than lower minimum CDs.

A customer can earn a potentially higher interest rate with the time deposit account than they would receive by depositing into a standard savings account or an interest-bearing checking account. The customer gets a higher rate because the time deposit funds remain locked until the maturity date of the account. A certificate of deposit is a type of time deposit with maturity dates from 30 days to up to five years.

These investments have Federal Deposit Insurance Corporation (FDIC) coverage of up to $250,000 per investment. Time deposit accounts sold by a credit union carry protection from the National Credit Union Administration (NCUA).

If required, the funds can be withdrawn from these accounts without notice. However, the owner will pay the penalty for early withdrawal. This penalty could include a set fee, or the customer might lose the interest earned by the account up to the moment of withdrawal. Different banks might have specific conditions surrounding the ability to withdraw the funds. It is due to this sacrifice of liquidity that banks offer higher interest rates compared to most basic savings 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 funds 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.

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 the investment matures, the funds can be withdrawn without penalty. The investor may also choose to renew the time deposit account 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 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 annual percentage yield is the effective annual rate of return (RoR) 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 received each month, a feature that some products offer. However, if the customer reinvested the earned interest for the term of the note, they 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.

As with most financial products, there are advantages and disadvantages to time deposit accounts. While these investments are safe and offer flexible entry points for the investor, the rate of return is usually lower than that received on other investments. The investor could invest the same funds into other stocks or bonds and receive a higher yield.

Since the investor has their funds tied up into the account, they may experience interest rate risk. Also known as market risk, this is the danger that market interest will rise to a level that is higher than what the time deposit account is returning.

Investors also face a risk in reinvestment during times of falling interest rates. When the investor gains access to their funds if market rates are less than they earned on the time deposit account they will be unable to reinvest the funds and get the same return.

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 1.39%.
• 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 both banks can change at any time.