What Is a Term Deposit?

What Is a Term Deposit?

Let me explain what a term deposit is: it's a savings tool where you deposit money into an account at a financial institution. These investments typically have short-term maturities from one month to a few years, require varying minimum deposits, and pay you a fixed interest rate.

You need to understand that when you buy a term deposit, you can only withdraw your funds after the term ends. In some cases, you might get early termination if you give notice, but expect a penalty for that.

Examples include certificates of deposit (CDs) and time deposits. Term deposits are often used by savers who want a low-risk way to grow their money without immediate access.

How a Term Deposit Works

When you deposit funds at a bank, the bank uses that money to lend to others. In return, they pay you interest. With regular accounts, you can withdraw anytime, which makes it hard for the bank to plan lending.

That's why banks offer term deposits: you agree not to withdraw for a fixed period, and they give you a higher interest rate. This rate is slightly higher than on standard savings or checking accounts because your access is limited.

These are extremely safe, sold by banks, thrifts, and credit unions, with FDIC or NCUA insurance.

How a Bank Uses a Term Deposit

If you place money in a term deposit, the bank invests it in products with higher returns than what they pay you. They can also lend it out at higher rates to borrowers.

For instance, they might pay you 2% on a two-year deposit and charge borrowers 7%, netting a 5% margin. This net interest margin is key to their profitability.

Banks aim to pay low on deposits and charge high on loans, but they must balance to attract depositors and borrowers.

Term Deposits and Interest Rates

In rising interest rate periods, you're more likely to buy term deposits as saving becomes attractive, and banks offer higher rates. When rates fall, demand drops because other investments pay more.

Rates should match the term length and deposit size—longer terms and larger amounts get higher rates. For example, a jumbo CD over $100,000 pays more than a small one.

Opening or Closing a Term Deposit

Term deposits, also called CDs, come with a statement showing minimum principal, rate, and term. If you close early, you face a penalty, often losing interest, as per the Truth in Savings Act.

Sometimes, if rates rise a lot, it might make sense to close early and reinvest, but calculate if it covers the penalty. Banks notify you near maturity for renewal or other options.

If it's a retirement CD, talk to a planner about early withdrawal rules.

Inflation and Term Deposits

Term deposits often don't keep up with inflation. If your rate is 2% but inflation is 2.5%, you're effectively losing purchasing power.

Laddering Strategy

Instead of one big deposit, spread funds across multiple CDs with staggered maturities. This laddering gives you regular access as they mature, and you can reinvest at current rates.

For example, put $3,000 each into one- to five-year terms; one matures yearly for withdrawal or rollover. It's great for retirees needing steady income.

Pros and Cons of Term Deposits

On the positive side, they offer fixed interest over the term, are risk-free with insurance, allow laddering for flexibility, have low minimums, and pay more for larger deposits.

Drawbacks include lower rates than some fixed investments, penalties for early withdrawal, failure to beat inflation, and risk of missing higher rates if locked in during rises.

Example of Term Deposits

Take Wells Fargo: as of May 28, 2025, a six-month CD with $2,500 minimum pays 2.00%, and a one-year does the same. Rates can change and vary by location, influenced by yield curves.

Explain Like I'm 5

A term deposit means you give your money to the bank to keep for a set time, like six months. You can't touch it early without a penalty, but at the end, you get it back plus extra interest—more than a regular savings account because the bank can use it confidently.

How Will I Use This in Real Life?

If you have cash you won't need soon, use a term deposit for low-risk growth with better interest than savings. It's ideal for fixed returns without market volatility, but ensure you can wait out the term.

What Is the Disadvantage of a Term Deposit?

The main downside is no access without penalty, so only use it if you're sure. You also can't add more money, and it might not suit ongoing saving.

What Is Better Than a Term Deposit?

It depends on you: if you need access, try a high-yield savings account with no restrictions and potentially higher rates. Regular savings work if you're unsure about needing the money.

What Is the Difference Between a Term Deposit and a Certificate of Deposit?

A CD is a type of term deposit; the term is general for fixed-period savings with interest and penalties for early withdrawal, sometimes used interchangeably by region.

The Bottom Line

If you have extra cash, a term deposit earns more than savings while staying safe and simple. Longer terms pay more, but avoid if you might need the money early. It's good for conservative savers avoiding market risks, even if it doesn't always beat inflation.