Understanding the different types of term deposits offered by banks
- Term Deposits allow you to invest a sum of money for a fixed period at a fixed interest rate.
- There are two types of Term Deposits – Fixed Deposits and Recurring Deposits.
- It is called a “Term Deposit” because the money is invested for a fixed “term”.
- Premature withdrawal in a Term Deposit is allowed with a penalty.
- Term Deposits are safe investment instruments, unaffected by market volatility.
For money to grow, you need to invest in various instruments while mitigating your risks. Your investment portfolio should comprise of securities that earn high returns and those that safeguard your investment. While investors looking for quicker returns opt for equity investments, those looking to secure their capital and earn stable returns opt for debt instruments. A Term Deposit is one such debt instrument. Let us find out what it is in this article.
What is a Term Deposit?
A Term Deposit is an investment instrument wherein you can deposit a sum of money for a fixed period, at a fixed interest rate. In theory, a term deposit is the same as a Fixed Deposit in that you lock away your money for a fixed tenure. However, unlike Fixed Deposits, where you can opt for cumulative and non-cumulative interest payments, banks pay interest on Term Deposits only when the deposit matures. As such, when the deposit matures, the bank with which you open the deposit, will pay you the principal amount and the interest payable as a lump sum.
Characteristics of Term Deposits
- Term Deposits have a fixed tenure and interest rate.
- Term Deposits are essentially risk-free investments in that you get back your capital on maturity.
- Banks allow you to apply for Loans against Term Deposits.
- You can invest as low as INR 1000 in Term Deposits with most banks.
- You can avail of the rollover facility, reinvest your principal amount and interest, and create a new Term Deposit.
Types of Term Deposits
There are two types of Term Deposits:
As the name suggests, a Fixed Deposit or FD is an investment option where the bank offers a fixed interest rate for a fixed tenure. To open this term deposit account, you have to deposit a one-time lump sum amount at the commencement of the FD period. You can choose your preferred investment duration or tenure of Fixed Deposits, which can range from 7 days to 10 years. You can also withdraw the deposit before the maturity period, but you may be liable to pay a penalty for the same. While the minimum amount of FD differs from bank to bank, it can be as low as INR 1000. Also, the interest rate on FDs ranges from 4% to 7.5% - includes the base rate of the RBI, and the additional rate, which differs from one bank to another.
There are various types of Fixed Deposits an investor can opt for depending on their requirements
- You can opt for a cumulative deposit wherein the interest earned is reinvested into the deposit, and you get the capital amount and interest pay-out when the FD matures.
- You can opt for a non-cumulative FD, wherein the bank pays interest on a weekly, quarterly, semi-annual, or annual basis.
- You can also opt for a Sweep-in facility wherein the amount above a particular upper limit set by you in your Savings Account is automatically converted to a Fixed Deposit.
- You can opt for Tax-saver Fixed Deposits under Section 80C of the IT Act, wherein you can avail of a tax deduction of up to INR 1.5 lakhs.
A Recurring Deposit is a type of Term Deposit wherein you deposit a fixed amount (like instalments) for a fixed interval. In most cases, this interval is once a month. Like an FD, the rate of interest is fixed here and does not change throughout the tenure of the RD. You can choose RDs with flexible tenures ranging from 6 months to 10 years.
While the minimum amount of RD differs from bank to bank, it can be as low as INR 1000. Banks typically pay an interest rate ranging from 4% to 7.5%. Like a Term Deposit, you get the principal amount and interest payable when the RD matures. You can also pause your RDs mid-term by bearing specific penalties.
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Term Deposits Vs Fixed Deposits
The significant difference between a Term and Fixed Deposit is on the interest payment component. Essentially, Term Deposits are cumulative deposits, wherein you earn interest only when the deposit matures. As for Fixed Deposits, you can choose between cumulative and non-cumulative interest pay out. If you aim to create a lumpsum amount at the end of the deposit term, you should opt for Term Deposits. Conversely, if you wish to create an additional monthly or quarterly income source, you can opt for a non-cumulative FD.
How a Bank Uses a Term Deposit?
As we know, the primary operations of a bank are lending and borrowing. The bank uses the money from Term Deposits created by investors to invest in other financial products that pay a higher rate of return. This, in turn, allows the bank to pay you interest on your deposits. The bank may also use the Term Deposits to lend money to borrowers for various loans and earn high interest on the loaned amounts.
A Term Deposit is considered one of the best and safest investment options. It protects your capital and provides guaranteed returns. Term Deposits are ideal for investors with a lower risk appetite looking to earn a fixed source of income or create a lump sum deposit.
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*Disclaimer: This article is for information only. We recommend you get in touch with your income tax advisor or CA for expert advice.