Term Deposit vs. Demand Deposit: What's the Difference?

Term Deposit vs. Demand Deposit: An Overview

Term deposits and demand deposits refer to two different types of deposit accounts available at a bank or similar financial institution, such as a credit union. Demand deposits and term deposits differ in terms of accessibility or liquidity, and in the amount of interest that can be earned on the deposited funds.

Term Deposits

Term deposits, also known as time deposits, are investment deposits made for a predetermined period, ranging from a few months to several years. The depositor receives a predetermined rate of interest on the term deposit over the specified period. Funds deposited for longer periods command a higher interest rate. Term deposit accounts pay a higher rate of interest than traditional savings accounts.

Funds cannot be withdrawn from a term deposit account until the end of the chosen period without incurring a financial penalty, and withdrawals often require written notice in advance. At the end of the period, the depositor has the choice of withdrawing deposited funds plus earned interest, or rolling over the funds into a new term deposit. The most common form of a term deposit is a bank certificate of deposit or CD.

Demand Deposits

Demand deposit accounts offer greater liquidity and ease of access as compared to term deposits but pay lower interest rates, and they may also include various fees for handling the account. Depositors can withdraw any or all of the funds in a demand deposit account at any time without penalty or prior notice required, although some banks charge a small fee if you exceed their limit of monthly withdrawals.

Funds a depositor may need to access at any time should be kept in a demand deposit account. Examples of demand deposit accounts include regular checking accounts, savings accounts, or money market accounts.

Key Differences

There are several key differences between term deposits and demand deposits. Some of the more prominent differences are below.

• Purpose: Term deposits are savings accounts having a set term or period of time. The main objective of a term deposit is to give people a secure location to invest their money for a set amount of time at a set interest rate. Customers who frequently need access to their money for a variety of financial activities can use demand deposits.
• Accessibility: As mentioned before, term deposits are fixed-term investments with fixed maturities that typically range from a few months to many years. The money is usually locked up during this time. Regarding demand deposits, customers are not subject to any limitations while taking money out of their accounts or making payments.
• Rate of Interest: When compared to demand deposits, term deposits often offer higher interest rates. Typically, a term deposit's interest rate is predetermined at the time the account is opened and remains that way for the duration of the term. In exchange for liquidity, demand deposits typically have lower interest rates as their main purpose is to offer simple transactional services rather than produce a sizable interest revenue.
• Flexibility: Demand deposits are more adaptable than term deposits. Customers often cannot add or withdraw money from a term deposit account once it has been opened. The interest rate on a term deposit may also be fixed for the period.
• Investment Objective: Term deposits are frequently utilized as investment vehicles. Term deposits are an investment option for customers wishing to receive a safe and reliable return on their funds over a certain time frame while realizing very little investment risk. Alternatively, demand deposits are used largely as transactional accounts for handling daily finances. They are normally not regarded as investment accounts.

Money Market, Checking, or Savings?

Money market accounts have low fees and generally offer higher returns than savings accounts, however, the fluctuation of interest rates means no fixed amount of interest is earned on the account.

Checking accounts typically have higher fees and do not pay any interest to the holder, although some checking accounts earn a slight amount of interest. These accounts are favorable for individuals doing a lot of business or those who frequently need to access funds immediately for the purchasing of goods or services. Savings accounts are demand deposit accounts that typically have no fees attached. Interest rates on savings accounts are fixed and lower than interest rates available on time deposits. Both checking and savings accounts are accessible by the account holder through various banking options, such as teller service, online banking, and ATMs.

The Federal Reserve’s Consumer Compliance Handbook lists the basic characteristics of demand deposit accounts: no limitations on transfers or withdrawals made by the account holder; no maturity period, or an original maturity of six days or less; funds are paid on demand; the account may not bear interest; and there are no eligibility requirements.

Deposits and Financial Institutions

Term deposits and demand deposits are two types of deposits that impact a financial institution's stability, liquidity, profitability, and customer relationships. Term deposits provide a stable source of funding, allowing financial institutions to plan and allocate resources accordingly. For example, an institution knows how much capital is being locked up for a certain period of time, so they may more aggressively loan out those funds in the interim and hold less bank reserves.

Term deposits are also a way to attract and retain customers. Financial institutions will often provide an incentive period to attract a customer; for example, a certificate of deposit may have a higher-than-market rate for a given term. By luring the customer in with the rate, the institution often hopes they may be able to retain that customer easier at the end of the term deposit.

On the other hand, financial institutions relate demand deposits with everyday banking transactions. Banks lean on demand deposits to providing various services, helping build customer relationships that may springboard into other services such as creating loans. Though these deposits also play a crucial role in lending activities, there is more risk and uncertainty around the liquidity and lock-up period for the bank.

The Bottom Line

Demand deposits are transactional accounts designed for everyday banking needs, offering immediate access to funds through methods like checks, debit cards, and online transfers. On the other hand, term deposits are savings accounts with fixed durations and higher interest rates. They require depositors to lock in their funds for a specific period, limiting access until maturity. Term deposits are suited for individuals seeking secure returns over a fixed timeframe, while demand deposits prioritize liquidity and convenience for frequent transactions.