How Does Fixed Deposit Work in India: Example, Types, Feature

Fixed Deposits are a popular investment option known for their low risk and consistent returns, making them a preferred choice in many countries. Many wonder, “How does a fixed deposit work?” A lump sum in a fixed deposit often proves more fruitful than a regular savings account, mainly because FDs provide better yields.

One can open an FD with a bank, a deposit-taking Non-Banking Financial Company (NBFC), or a post office. While the minimum investment might vary, there’s generally no maximum limit. The core question is: How do these accounts benefit banks and financial institutions? We’ll delve into this, focusing on prominent institutions like HDFC and their various FD options.

How Does a Fixed Deposit Work?

Fixed Deposits (FDs) are deposits for a predetermined period chosen by the investor at a fixed interest rate. When you invest in FDs, your money gets locked for the selected investment tenure, which can range between seven days and ten years. Now, let us look at how a fixed deposit account works.

Suppose you chose a two-year tenure for a bank deposit of Rs. 50,000. With the assurance that your investment is locked for the specified period, banks will utilise it for lending to borrowers – individuals or corporates. Banks function under an asset-liability management system. Your deposits are liabilities for banks, and the loans provided are assets. So, in opening an FD account, you are building liabilities for the bank.

The interest rates offered on FD vary across institutions and are based on your investment tenure and amount. Each financial institution fixes its interest rates depending on the repo rate changes, as announced by the Reserve Bank of India (RBI), from time to time. The important point to remember is during your FD tenure, even if interest rates fluctuate, you will be entitled to the rates promised at the time of opening the account.

However, the scenario changes when you withdraw prematurely. In this instance, you must pay a penalty or withdraw at a lower interest rate than the predetermined rate.

So, banks utilise your funds for a fixed tenure and in return, it pays you a predetermined interest on the deposit.

Also Read: Experience financial growth with unmatched Bajaj Finance FD Rates

Features & Benefits Of Fixed Deposits

Fixed Deposits come with a lot of features and benefits. Let’s take a look at each of them separately.

Features of FDs

Interest Rate: They offer a fixed or flexible interest rate based on your chosen scheme. This interest rate offering is typically higher than savings accounts.

Investment: Although higher than savings accounts, the minimum investment amount can be as low as 1000 INR, varying amongst different banks.

Liquidity Mechanism: FDs are not ideally known as highly liquid instruments. Given their lock-in period, they come with a premature withdrawal facility, although with a penalty when withdrawn.

Tenure: Fixed deposits have a wide array of tenures, ranging from 7 days to 10 years.

Loan against FD: Many banks allow you to take a loan against an FD for up to 95% of the investment value.

Renewal Facility: FDs can be renewed after running their course across the set term.

Taxation: The interest earned on FDs is taxable, with many banks offering tax-saving FDs typically offered for 5 years.

Benefits of FDs

Safe and Stable Returns: FDs, particularly with established banks or institutions, are among the safest investments, ensuring steady returns due to fixed interest rates.

Compound Interest and Savings Growth: Some FDs compound interest, calculating it on both the principal and previously earned interest. This fosters a disciplined savings approach as funds are locked in for a set duration.

Flexibility and Diversity: FDs come in various tenures to suit different financial goals, and there’s a variety of types, including cumulative, non-cumulative, and tax-saver.

Convenience: Setting up and managing FDs is straightforward, whether done digitally or in person.

Types of Fixed Deposits

Now, let’s look at the various types of FDs.

Standard Fixed Deposits

A standard FD is an FD scheme in which you can invest a lump sum amount for a fixed tenure at a fixed interest rate. This interest rate set by the bank remains the same throughout the predetermined tenor and is typically higher than a savings bank account. This tenure may vary from seven days to 10 years, depending on the financial institution where your account is being opened.

Corporate Fixed Deposits

Investors can make deposits with corporates in order to yield high returns in comparison to Standard FDs.Generally, financial institutions and deposit-taking NBFCs (Non-Banking Financial Companies) offer such deposits.

These deposits are risky and unsecured i.e if the company defaults, investors might not be able to recover the amount.

Tax-saving Fixed Deposits

A tax-saving FD is an FD scheme that allows you to save taxes on the gains from your deposits. As per Section 80C of the Income Tax Act, 1961, you can avail tax deductions on investments up to Rs. 1,50,000 per year. However, in this case, the lock-in period would be five years.

Cumulative Fixed Deposits

Under this scheme, your interests will be accumulated until maturity, with periodic compounding.  The interest earned every year gets added to your principal amount and is paid upon maturity. Generally interest is compounded quarterly in case of cumulative FD.

Non-cumulative Fixed Deposits

In a non-cumulative FD, the interest income is paid at specific intervals – monthly, half-yearly, quarterly or yearly.

Senior Citizen Fixed Deposits

People above the age of 60 years are eligible to open a senior citizen FD account. The interest rate provided in this FD scheme is higher by 0.5-0.75% than the interest rate provided on standard FD schemes.

A senior citizen can claim savings and fixed deposits interest deduction restricted up to Rs 50,000 under section 80 TTB the provision is exclusively for senior citizens.

Flexi Fixed Deposits

A Flexi FD is formed by combining a fixed deposit and a demand deposit. It allows investors to enjoy the liquidity of savings or current accounts and the higher interest rates offered by an FD account. Here, you link an FD account with a savings account. After making an initial deposit in an FD account, you set the balance limit for your savings account. Flexi deposits have access to the auto sweep feature if the balance in the savings account exceeds the limit, the excess amount can be transferred to the FD account automatically.

Types of Interest on Fixed Deposits

There are multiple forms of interest payouts when it comes to Fixed Deposits. Let’s take a look at each of them:

Non-Cumulative Interest: This type of interest is among the most common payouts across the investment demographic. Non-cumulative interest is also known as Monthly or quarterly interest payment. This payment scheme can be very beneficial for those with a need for a stable income every month or quarter.

Simple Interest: Your initial deposit is the deciding factor in determining the interest. The bank only calculates interest on the amount you first deposited, not any interest earned. So, even if you keep the FD for many years, the bank will still base the interest on the starting amount.

Compound Interest: For long-term investors, compound interest is exciting. It means you earn interest on both your original money and the interest already gained. So, your money grows faster than with basic interest.

Cumulative Interest: Ideal for investors who do not need a stable income source every month but the lump sum amount at the end of the FD life. This is done by adding the interest to the principal amount once every three months, after which the interest and principal are paid after maturity.

Example – How is Interest of Fixed Deposit (FD) Calculated?

Let’s take a look at an example through a scenario:

After receiving his annual bonus of ₹1 lakh, Rohit decided to invest it in a fixed deposit. Being a thorough individual, he researched and found two options: one offering simple interest and the other offering compound interest. Let’s see how his investment would grow in each case over 3 years.

1. Simple Interest in FD:

Rohit finds a bank offering an FD at 6% per annum for 3 years.

Rohit earns ₹1 lakh × 6% = ₹6,000 each year.
Over 3 years, Rohit gets ₹6,000 × 3 = ₹18,000 as interest.

After 3 years, adding his interest to his principal, Rajesh would have ₹1 lakh + ₹18,000 = ₹1.18 lakhs.

2. Compound Interest on FD:

Another bank catches Rohit’s eye with a 6% interest rate compounded annually for 3 years.

First-year:
Interest on ₹1 lakh is 6%, which equals ₹6,000. By the year’s end, Rohit has ₹1.06 lakhs.

Second-year:
On the new amount of ₹1.06 lakhs, he earns 6% interest, which is ₹6,360. Now, he has ₹1.12 lakhs and 360 rupees.

Third-year:
Now, 6% interest on ₹1.12 lakhs and 360 rupees is around ₹6,741.60.

By adding this interest by the end of 3 years, Rohit would have approximately ₹1.19 lakhs.

With compound interest, Rohit earns about ₹1,000 more over 3 years because the interest gets added to the principal every year, and he earns interest on that added amount.

First-year:
Rohit earns 5% on ₹10,000, which is ₹500. So, by the end of the year, Rohit has ₹10,500.

Second-year:
Rohit earns 5% on the new amount, ₹10,500, which is ₹525.

Adding this to ₹10,500, Rohit gets ₹11,025 in total after 2 years.

So, with compound interest, Rohit earns a little extra (₹25 more in this example) because he’s getting interest on interest.

How to Open a Fixed Deposit (FD) Account?

To open a Fixed Deposit (FD) account, you can follow these steps;

FD Opening via Online Method

1. Log in to your banking application.
2. Navigate to the ‘Transact’ or a similar option and select ‘Open Fixed Deposit’ or its equivalent.
3. If required, choose the bank branch. Provide the necessary details.
4. Specify the desired deposit amount, tenure and nominee information.
5. Carefully review all the provided details. Confirm.

Offline FD Opening

1. Visit your bank branch in person.
2. Request an FD application form from the bank personnel.
3. Fill out the form accurately. Gather all the documentation as instructed.
4. Submit both the completed application form and supporting documents to a bank representative.

Please note that each bank may have procedures for opening an FD account so it’s advisable to contact your specific bank for precise instructions.

Who is Eligible For FD?

The following are eligible to open a fixed deposit account with a bank/NBFC in India:

• A resident Indian citizen
• Non-Resident Indians (NRIs)
• Hindu undivided families
• Trusts
• Government departments
• Sole-proprietorship businesses
• Clubs
• Public or private companies
• Partnership firms
• Societies
• Associations

Documents Required for Fixed Deposits

Identity Proofs:

• PAN card (For individuals, companies, societies, HUFs)
• Aadhaar card
• Driving licence
• Passport
• Voter’s ID card

Address Proofs:

• Passport
• Voter’s ID card
• Latest utility bills
• Rent agreement
• Property deed

Final thoughts

FD is one of the safest investment instruments you will come across. However, knowing how a fixed deposit works will not be enough to help you make a decision; you should also consider parameters like interest rate, tenure, maturity amount, and terms and conditions related to premature withdrawal before investing in a scheme. Additionally, and most importantly, assess your financial goals before investing.

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