:max_bytes(150000):strip_icc()/Julia_Kagan_BW_web_ready-4-4e918378cc90496d84ee23642957234b.jpg)
:max_bytes(150000):strip_icc()/ProfilePhoto-b1e48e2bd8ac40099b2b7a4d21e9d648.jpg)
:max_bytes(150000):strip_icc()/DepositInterestRateDefinitionFixedVs.Variable-15bcc5e2cf294cbaac66d862bed06f99.jpg)
What Is a Deposit Interest Rate?
A deposit interest rate is paid by financial institutions to deposit account holders. Deposit accounts include certificates of deposit (CD), savings accounts, and self-directed deposit retirement accounts.
It is similar to a "depo rate," which can refer to interest paid on the interbank market.
Key Takeaways
- The deposit interest rate is paid by financial institutions to deposit account holders.
- Deposit accounts are attractive for investors as a safe vehicle for maintaining their principal, earning a small amount of fixed interest, and taking advantage of deposit insurance.
- The fixed interest rates guaranteed with certain deposit accounts tend to be small compared with the variable returns of other financial vehicles.
- In self-directed deposit retirement accounts, the types of investments being made can include real estate, mutual funds, stocks, bonds, and notes.
- Financial institutions encourage long-term deposits not only for the client’s benefit in the form of extended interest but because it offers the institution more liquidity.
Understanding Deposit Interest Rates
Deposit accounts are attractive places to park cash for investors who want a safe vehicle for preserving their capital, earning a small amount of fixed interest, and taking advantage of insurance such as that provided by the Federal Deposit Insurance Corp. (FDIC) and National Credit Union Administration (NCUA).
Most investment portfolios reserve a small allocation of the money invested to deposit accounts, as they provide the benefit of liquidity and capital preservation.
Ways Deposit Interest Rates Are Applied by Institutions
Financial institutions typically offer better rates for accounts holding larger balances. This is used as an incentive to attract high-value clients with considerable assets. When attaining a higher interest rate, naturally the greater the sum deposited, the larger the return over time.
The fixed interest rates guaranteed with certain deposit accounts tend to be lower than the more variable returns of other financial vehicles. The tradeoff is that the account holder is assured of gradual gains to their deposit versus the potential for sudden profits or even loses with higher-risk investments.
While this may still be seen as a slower growth approach for returns, such accounts can offer more stability than more volatile, high-risk financial products.
For instance, a certificate of deposit with a fixed rate is assured to furnish the stated return when the account reaches maturity. There are also CD accounts that offer variable rates, but these are still typically no-risk products.
In the case of certain self-directed deposit retirement accounts, the various types of investments being made can include real estate, mutual funds, stocks, bonds, and notes.
Banks, credit unions, and other financial institutions tend to offer competitive interest rates for these deposits to better attract customers. Depending on the product, premium deposit interest rates may only be available under certain terms such as minimum balances, and possibly maximums.
Financial institutions encourage long-term deposits not only for the client’s benefit in the form of extended interest earned, but also because they offer more liquidity to the institution.
Some accounts also require a set length of time—six months, one year, or multiple years—that the money must remain deposited and not accessed by the account holder. If the deposit is accessed and withdrawn early, there may be penalties and fees incurred, including the potential loss of the agreed-upon interest rate if the balance remaining in the account falls below a minimum.
By having more cash on deposit, an institution can make more lending transactions, such as loans and credit cards, available to its customers.
Which Deposits Pay More Interest?
The amount of interest you earn will depend on the interest rate offered and how much you have deposited in the account. The more money you put in and the higher the interest rate, the more interest you will earn. Generally, online banks pay better interest rates than bricks-and-mortar banks.
Does Every Bank Offer Deposit Interest Rates?
Yes, banks that provide interest-bearing deposit accounts will always offer a deposit interest rate.
How Does Calculation of the Deposit Interest Rate Affect How Much You Earn?
The amount of interest paid to your account is influenced by whether the interest rate is calculated separately for each day, or whether it is based on the average deposit or the minimum balance for each month. The account balance is the amount of savings in the account. You can get a better interest rate for an account when the interest is calculated based on the daily balance or the average deposit, because this method corresponds better to the fluctuation in the value of your savings.
The Bottom Line
A deposit interest rate is paid by financial institutions to deposit account holders. These accounts, like savings, CDs, and self-directed retirement accounts, are attractive for investors as a safe vehicle for maintaining their principal, earning some fixed interest, and for being covered by deposit insurance. However, the fixed interest rates guaranteed with deposit accounts tend to be small compared with the variable and often higher returns of other financial vehicles.