Term Deposits Explained

Term Deposits Explained

Term deposits, sometimes called certificates of deposit, differ from regular savings or checking accounts in that you agree to leave your money on deposit for a specified time, or term.  In return, the bank pays you a higher than average interest rate.  In many cases these accounts also require a higher opening deposit amount than a standard account.

The best savings rates are often found in term deposits, and the longer you agree to keep your funds on deposit, the higher the rate—though the rate advantage tends to narrow when the term extends past about 12 months.  Remember, you’re exposing yourself to a higher interest rate risk the longer you keep your funds tied up, and you’ll want the bank to reward you for that.

Once you make the deposit into a term account, there are early withdrawal penalties to contend with if you need to withdraw your money before the end of the term.  The information you receive before investing should outline these potential costs; if you don’t understand anything or it doesn’t seem clear, be sure to ask a customer service representative at the bank.  Early withdrawal penalties can be large enough to negate the extra interest you’re earning, so be sure you won’t need the money until the end of the term.

A few accounts will allow exceptions to the early withdrawal penalties for certain circumstances, like the death of one of the account holders.  Exceptions like these will be in the account agreement, which you should read before depositing money.

Think carefully about the term of the account before you open it.  The best deposit rates will be offered on the longest terms, but in exchange you’ll be exposing yourself to interest rate risk.  For instance, let’s say rates on an average savings account with no minimum balance are 2%.  You’ve found a 24-month account paying 4%–double the average.  That’s a great deal, until 12 months later, when rates have risen to 5% on regular savings accounts, and your money is stuck in the now low-interest account.  That is interest rate risk.

If you withdraw the money, you’ll pay a penalty, making the effective interest rate on your term account even lower than the advertised 4% rate.  If you leave the money in you’ll avoid the early withdrawal penalty, but you’ll be stuck in a rate that’s currently 1% lower than market rates, and could become even lower than market if other rates continue to rise.

And even though you won’t be moving money in and out of this account, access is important.  You may have a planned use for the funds once the deposit term is up, and electronic funds transfer will keep you from losing money while the funds are being mailed from the bank to you.

So, when it comes to term deposit accounts, the term is important, but so are the other account requirements.  The bank’s best deposit rates will usually be available in this type of account, which also requires minimum deposit amounts.  Think about your comfort level with different terms, and read all the material associated with this account type before you invest.