SoFi

A confirmed letter of credit is an important document to those who are launching or running a business, particularly those engaging in international trade. These letters are used to help protect both the business and their vendor. They essentially involve a bank guaranteeing payment of a transaction, which can inspire confidence and allow a deal to go through.

Here, we’ll take a closer look at this document and learn:

•   What a confirmed letter of credit is

•   How a confirmed letter of credit works

•   What a letter of credit contains

•   The advantages and disadvantages of a confirmed letter of credit

What Is a Confirmed Letter of Credit?

Here’s what a confirmed letter of credit is: Also known as a confirmed LC, it is an additional guarantee for a payment by a secondary bank. It states that this additional bank will be responsible for a payment being on time and in full even if the buyer doesn’t meet their contractual obligations and the first bank (called the issuer) can’t make payment or in default. You might think of it as a kind of insurance policy or Plan B if the initial bank responsible for payment failed to do its job.

This type of document can be common in international trades, such as in export and import businesses. In many cases, a guarantee may be required to conduct international transactions or when a vendor or seller has reason to doubt the first bank’s creditworthiness.

How Confirmed Letters of Credit Work

Confirmed letters of credit are commonly used as negotiable instruments, which are signed documents that promise to pay a certain sum to a specified person. It’s especially valuable in international business transactions that involve a significant payment amount for goods or services. Since the letter acts as guaranteed payment, it may take the place of a request for advance payment. (This can be helpful if an individual had been, say, considering taking out a loan to enhance their credit.)

To get a letter of credit, the buyer will likely need to submit required documents to the first bank, including proof that certain steps have been completed. Then the bank will send appropriate documents to the seller’s bank. This paperwork shares detailed instructions on the terms and conditions, as well as how payment should be made. Depending on the agreement between the buyer and the seller, payment may be made immediately or at an agreed-upon date.

Once the letter of credit has been issued, the buyer needs the backing of a second bank to get a confirmed letter of credit. Worth noting: A fee is likely to be involved. The exact amount of this fee may depend on how good (or questionable) the first bank’s credit is. This letter usually reflects the first letter of credit and uses the same terms.

A confirmed letter of credit can protect both parties because it decreases the risk of default for the vendor or seller. Additionally, it ensures that payment is only made if all the terms are met. It can be a step to building good credit when doing a deal with a new client. It can also be helpful for a business that is just starting out and making connections, building contacts, and monitoring its credit.

Parties Involved in a Confirmed Letter of Credit

The following are all the parties typically involved in a confirmed letter of credit:

•   Buyer or applicant: This is the party who is requesting the letter of credit and who will pay the seller.

•   Beneficiary or seller: The party who is selling goods or services and is the one who receives payment.

•   Issuing bank: This is usually a bank where the buyer already has a business bank account. It’s the one that issues the original letter of credit.

•   Confirming bank: This is the second bank that will guarantee the funds to the seller once the terms in the letter of credit are met. In some cases, the confirming bank is from the seller’s home country (this may be called a correspondent bank) or is a bank the seller already works with.

Confirmed Letter of Credit Example

Let’s look at an imaginary example of how a confirmed letter of credit could work. Say that Pauline’s Paper Goods receives an order for 100,000 pallets of customized notebooks from JessCo, a stationery company. Pauline’s Paper Goods has never worked with JessCo before and isn’t sure that this company has the means to pay for the goods. Maybe Pauline’s Paper Goods worries that JessCo doesn’t have what is considered good credit.

In order to prevent non-payment after the notebooks are produced and shipped off to the buyer, Pauline’s Paper Goods outlines an agreement that JessCo needs to pay with a confirmed letter of credit on the date the shipment leaves their warehouse.

If JessCo agrees, it would start applying for a letter of credit at its bank, where it has its checking account, in the United States. If the bank requires it, the company needs to provide proof it has the funds available or it will apply for financing.

As soon as the issuing bank creates the letter of credit, JessCo then applies for a confirmed letter of credit with another bank, possibly the seller’s bank. When Pauline’s Paper Goods receives the completed confirmed letter, it manufactures and ships the customized notebooks. Once Pauline’s Paper Goods provides proof of when and how the goods were shipped, the guaranteed funds are released.

Confirmed vs Unconfirmed Letters of Credit

If you are conducting international business, you will probably hear the terms confirmed and unconfirmed letters of credit. An unconfirmed letter of credit is simply a letter of credit issued by a bank. A confirmed letter of credit, as we’ve described above, is backed by two banks. This can foster trust if, say, there’s reason to worry the payment won’t be made. (Perhaps one company involved has a less than stellar credit rating; this is one situation that shows why bad credit can be a big deal.)

The following are other differences between the two:

•   Guaranteed payment: With a letter of credit, the issuing bank guarantees payment. With a confirmed letter of credit, however, two banks confirm payment.

•   Cost: Unconfirmed letters of credit tend to cost less than confirmed letters of credit.

•   Changes: The buyer is allowed to make changes to an unconfirmed letter of credit. With a confirmed letter of credit, both banks can modify the document.

•   Issuance: The seller only has to approach one bank for an unconfirmed letter of credit, but needs to contact two with a confirmed letter of credit.

Advantages of Confirmed Letters of Credit

Confirmed letters of credit can have several benefits for sellers, particularly those doing business internationally and wanting to ensure smooth transactions. These advantages include:

•   Protection for both the buyer and seller

•   An extra layer of confidence for the seller

•   A lower risk of default thanks to a reputable second bank (perhaps serving as a guarantor if the first bank has a credit rating that varies)

•   Buyers can seem more creditworthy, which may increase the odds that a seller will do business with them

Disadvantages of Confirmed Letters of Credit

While confirmed letters of credit can be very valuable in business, there are a couple of downsides to recognize. Disadvantages of confirmed letters of credit include:

•   It may take longer to get a confirmed letter of credit since an additional bank is involved

•   Bank fees may be higher than with an unconfirmed letter of credit

The Takeaway

A confirmed letter of credit can be a valuable business tool, especially when conducting international business. For those importing or exporting, the letter will guarantee payment for goods a company is supplying if the buyer and the buyer’s bank can’t complete the deal. Getting a confirmed letter of credit may cost more and take longer compared to an unconfirmed letter of credit, but the effort may be worth it. It can secure a transaction and open doors to doing business with new customers in a way that communicates confidence.

Having confidence in your banking partner is an important aspect of your financial life. That’s why you may want to give SoFi a closer look for your personal accounts. SoFi may be just the right match. Here’s why: When you open an online bank account with direct deposit, you won’t pay any fees (no account, monthly, minimum-balance or overdraft charges). You will, however, earn a super competitive APY. In other words, your money could grow faster.

FAQ

What is an unconfirmed letter of credit?

An unconfirmed letter of credit is a letter of credit that’s only been issued by one bank, known as the issuing bank. In a transaction, the buyer requests an unconfirmed letter of credit to guarantee funds will be paid on time to the seller by the bank.

Is an unconfirmed LC safe?

Yes, it’s safe because there is guarantee or confirmation from one bank that payment will be made. Assuming that the issuing bank has a high credit rating, the seller can feel confident that the funds will be paid once all the conditions in the contract have been met. If the seller wants an additional layer of security, they may request a confirmed letter of credit — which means a second bank will guarantee payment if the first one fails to do so.

What is the risk of an unconfirmed LC?

The risk of an unconfirmed letter of credit is that the issuing bank won’t have the funds to pay the seller. That means even if the seller completes their end of the contract, they risk losing out on funds if the issuing bank doesn’t fulfill their promise.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOBK0422048

Most of us wish it were easier to save money, whether we’re the sort of person who’s having trouble making ends meet or the kind who wants to save up for a big purchase. Here’s one simple solution: The 100 Envelope Challenge. It’s a creative and easy way to save money. If you commit to the challenge, you can save $5,000 in just three months.

Here’s a closer look at this clever way to stash some cash. We’ll review what daily money saving challenges are, such as the 100 Envelope Challenge and other variations on the theme, and how to put them to work for you. Whichever one you try, if you stick with it, you’ll have a major amount of moolah at the end of the exercise.

A Daily Money Saving Challenge

Daily money saving challenges help you save cash instead of spending it. The 100 Envelope Challenge is one of the latest trends in this kind of money hacking. It’s a great way to add more cash to an emergency fund or just help you manage your money with more focus and pumped-up results. This can be a fun daily activity that allows you to be more disciplined with your hard-earned cash. Instead of making impulse purchases, you’ll learn this smart saving habit that can get you excited about building up your money reserves for the future. Just one note: Most of these saving techniques involve cash (bills and coins), but there are some work-arounds if you are a person who mostly uses plastic.

What Is the 100 Envelope Challenge?

The 100 Envelope Money Challenge can be an easy way to save money and upgrade your budgeting skills. This challenge involves starting with 100 envelopes and labeling them from 1 to 100. Take the numbered envelopes and place them all in a large container or box.

Then, for the next 100 days, you randomly select an envelope from the container and put the amount of cash that’s labeled on the front inside the envelope. For example, if you pull out an envelope number 25, you place $25 in that envelope. Tuck that envelope somewhere safe, and repeat the process until you’ve reached the 100th day. That’s it: You’ve completed the challenge! And you now have $5,050 to deposit in savings, pay bills, spend, or invest.

How Can I Save $5,000 in 3 Months?

The 100 Envelope Challenge, as you’ve just read, is a gamified way to salt away more than $5,000 in three months. People who stick with the challenge daily for the 100 days will have $5,050. Obviously, the days where you pull a lower-number envelope are easier to manage than the day you grab an envelope that’s waiting to be stuffed with a whopping 90-some dollars. The tricky part is keeping up with the challenge, regardless of the amount required. It can be helpful to keep track of your progress by recording a running tally of how much is saved over the months. As you see the amount grow, it may help you stay motivated about saving money.

You may be concerned that this challenge requires an outlay of cash every single day for three months. What, you may wonder, will I do if I don’t have cash handy? Here’s some good news: This daily money saving challenge can be done digitally as well. In the digital method, you would still need 100 envelopes to pick from everyday. But instead of placing the money in physical envelopes, participants can open a new bank account that’s separate from their everyday savings account. Perhaps your financial institution will even allow you to name the account “100 Envelope Challenge.” Link this account to your checking so you can transfer funds into it. When you pick an envelope with its designated number, transfer that amount to your new savings account.

In this version, you will still have $5,050 at the end of the 100-day challenge, even if you never handle any paper money during the 100 days. You may well emerge at the end of the challenge with a renewed appreciation of the fact that saving money is important.

Recommended: How to Transfer Money between Banks

Other Money Saving Challenges

There are a variety of creative ways to save money and build up your savings. It’s important to find one that feels like fun and fits your lifestyle and financial situation. You’ll be more likely to use it when managing your money. Here are some options to consider.

52-Week Money Challenge

The 52-week money challenge is another effective way to save for those who want to start out small and slowly work their way to saving more. This challenge involves saving $1 the first week, $2 the second week, $3 the third week and so on. The sequence continues until you reach week 52 when you save $52 dollars. If you stay consistent, at the end of this challenge, you will have saved a total of $1,378 over the course of a full year.

It’s an impressive amount of savings considering you never had to put in more than $52 per week. It shows that a little can eventually go a long way. This challenge can be especially effective because the amount of money stowed away each week is minimal. You may find you can complete this challenge without making much of a shift in your daily or monthly budgeting.

8-Week Vacation Savings Plan

If you have your sights set on taking a vacation, but aren’t sure how you’ll afford it, the 8-week vacation savings plan could be a perfect solution. It will help you speedily save money for a trip ($1,000 to be exact).

To participate, you’ll need to open a bank account devoted to vacation savings. Then, you save $1,000 by following this schedule of how much to save:

Week 1: $10
Week 2: $25
Week 3: $75
Week 4: $150
Week 5: $150
Week 6: $75
Week 7: $25
Week 8: $10

There’s something about that bell curve or “up the mountain, down the mountain” pattern to saving that makes it feel manageable.

Then, to save the rest of the $1,000, make some smart swaps. You may know some basic budgeting moves, like cooking at home instead of dining out. If, over the eight weeks, you cut out one $50 restaurant meal per week that’s $400 more saved that can go into your account.

If you have coffee at your home or office instead of getting a fancy espresso drink to go twice a week, that will save $10 per week. Over eight weeks, that’s the additional $80 that brings you to the $1,000 total.

Another tip: If you can afford it, try to save from your salary. You might set up automatic deductions that whisk some money out of your paycheck and move it into savings before you can spend it. These tactics will help you have a nice pile of cash so you can go on your getaway.

365-Day Nickel Savings Challenge

The 365-Day Nickel Savings Challenge is another way to accumulate a bundle of cash, and it starts with saving just a nickel a day. On day two, you set aside two nickels. On day three, you set aside three nickels and so on. Each day, you increase your savings by one more nickel. This challenge goes on for a full year. On the last day of the challenge, you save $18.40 and your total savings for the 365 days will amount to $3,300. Similar to other money savings challenges, you start out small with this challenge. But in this case, you begin super-small (just loose change, actually) but you wind up gathering a significant amount when the challenge is complete.

Spare Change Challenge

The Spare Change Challenge allows you to save money using change you have around your home that you may have forgotten about. This can be as easy as taking loose change and adding it to a piggy bank. When it’s filled to the brim, take the jar and add the money to your savings account. Other people have variations on this theme. For example they might make a point of paying for purchases with paper money, and then always putting the coins they get as change into a savings account. You’d be surprised at how those coins can add up to thousands of dollars over time.

Expense Tracking Challenge

Tracking your purchases can be a financially healthy exercise to know exactly how much you are spending on purchases. You can see in which categories your spending clusters, too. Doing this will help you realize if you’re making financially wise money decisions or if you are spending money on impulsive, possibly unnecessary purchases.

The Expense Tracking Challenge involves writing down your purchases for an entire month and reviewing what you bought. For some, creating the list as a spreadsheet may be easier. This exercise can reveal what type of spender you are and help you adjust money habits to be a smarter saver.

The Takeaway

Saving money challenges like the 100 Envelope Challenge can be a motivating and successful way to sock away some cash. They typically have you start out by contributing a small amount of money such as just one dollar. These gamified savings techniques provide motivation for you to stash away cash and see your savings account steadily grow. Building your savings skills this way can help you save larger amounts in the future. Whether your goal is to afford a vacation or the down payment on a house, these challenges can help you start saving.

If seeing your cash grow and building long-term wealth are among your money goals, come see what SoFi offers. When you sign up for our Checking and Savings with direct deposit, you’ll earn a competitive APY. Plus, you won’t pay any of the usual account fees, and you’ll have access to a network of 55,000+ fee-free ATMs. With these benefits, your money works harder for you.

FAQ

How much do you get from the 100 Envelope Challenge?

At the end of the 100 Envelope Challenge, which lasts 100 days, you will have saved exactly $5,050.

What is the 52-Week Savings Challenge?

The 52-Week Savings Challenge involves saving $1 the first week and increasing that amount by one dollar each week. By the end of the 52 weeks, you will have saved $1,378.

How can I save extra cash?

There are many ways to save extra cash. Using fun and simple money challenges can be a great way to get started saving for short-term goals or a big future purchase. Participating in the 100 Envelope Challenge, the 52-Week Savings Challenge, or even creating your own customized challenge can be a great way to improve your relationship with money.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Photo credit: iStock/solidcolours
SOMN0122006

These days, most of us do all kinds of tasks online. From scheduling a yoga class to booking a dinner reservation to ordering more toothpaste instead of grabbing it from a store, our smartphones and computers make it easy.

Still, there are some folks who don’t feel comfortable conducting their banking online. They worry perhaps that they’ll hit the wrong button and send thousands of dollars speeding off into unknown parts of the ether. Or maybe having a physical bank makes them feel more at ease, is more familiar to them, and they feel like their money is safer.

Those who prefer to do online banking may like the convenience of 24/7 access to their money. They may not have the time or inclination to wait in line or chat with bank tellers.

But is one style of banking better than another? To answer that question, let’s examine some pros and cons of digital banking.

Once we’ve examined these benefits and downsides of online banking, you can make an informed decision about what kind of banking is right for you. Maybe it’s even a combo of the two styles. Then, we’ll talk about how to move your banking to an online-only platform if that’s what suits you.

What Is Online Banking?

Consumers have a few different options when it comes to where they park their money and use it to complete transactions. The traditional options are to use a commercial bank with bricks-and-mortar branches or a credit union. A credit union is a financial co-op that is generally owned and operated by its members (as opposed to being a publicly-traded company).

Most traditional retail banks offer mobile banking as well as the ability to conduct business at a branch. Mobile or online banking in this sense allows you to look up your accounts and complete transactions online (more on the difference between the two terms in a minute). Typically, this means you can transfer funds and even mobile deposit checks.

But these added services are not what we are talking about today; here, we are discussing the use of an online-only or an internet-based bank versus a traditional bank. Online-only banks are a newer alternative to traditional banks. Sign up for a digital bank, and you will do all of your banking operations online. Online banks generally have no physical locations, which can help them to keep overhead costs low. In turn, they typically pass those savings on to you and offer some perks over traditional banks, such as a higher interest rate on savings accounts.

Because not all digital banks are the same, the following list of pros and cons won’t capture every nuance, but hopefully you’ll get an idea of what services are offered. Knowing these details should help you evaluate the benefits of both mobile banking and traditional banking and which one suits you best.

Recommended: Is Mobile Banking Safe?

Pros and Cons of Online Banking Services

If you’re used to turning up at your local bank branch and chatting with the tellers, digital banking may seem like a big shift. Or perhaps you’re a person who is already using mobile banking but you wonder if you’re missing out on any perks. In either case, take a look at what digital banking can offer. Here’s an assessment of the pros and cons of online banking.

Pros of Online Banking

Technology can offer some tremendous conveniences and perks to banking. Consider these pros of online banking:

Higher Interest Rates

As mentioned, banks without bricks-and-mortar locations tend to offer a higher rate of interest on cash savings accounts. Currently, the national interest rate on savings accounts is 0.06%.

This is a mere $.60 per $1,000 over the course of a year. On the other hand, an online bank is likely to pay 1% annual percentage yield (APY) or more, which amounts to $10 for every $1,000. This is obviously a significant improvement.

Recommended: APY vs. Interest Rate: What’s the Difference?

No Minimum Balance

Many traditional banks still require that you maintain a minimum balance or have an established automatic deposit or they will charge you a monthly fee. You may wonder how much money you need to open an account online. Some digital financial institutions do not require a minimum amount of cash be kept in your checking and savings accounts. Your balance in a digital bank account can be just a few dollars, and you still won’t be hit with charges on your statement.

Convenience

Online banks are open 24 hours a day, which some customers find useful for maintaining their finances and making transactions after normal bank hours. All you need is secure access to the internet. If you’re working an 8-to-6 job where you can’t sneak out to meet with a teller, the convenience of banking outside working hours is a gamechanger. Also, as we lead more fluid existences (say, working from home), there’s simply the time savings of being able to bank where you are versus walking or driving to a branch.

ATM Access

Most online banks will be part of an online network of ATMs, such as MoneyPass or Allpoint. There is generally no fee to use the ATMs, and customers can locate them online. If they do not use an ATM network, they will typically offer to refund ATM fees up to a certain number of withdrawals.

Cons of Online Banking

Of course, digital banking isn’t perfect. What is? There are some potential downsides to managing money this way, though many of them depend on your particular personal finance style. Here, some cons of online banking to keep in mind:

No Live Assistance

While most online banks provide a customer service line, they generally do not offer personal bankers. This means that there is no “live” person to help you with your banking needs, such as setting up accounts, applying for loans, getting a notary, or even just someone with whom you can discuss a simple issue or complaint. If you are a person who wants this kind of personal connection, you may not be well-suited to digital banking.

A personal relationship with a banker could come in especially handy in the event that you are trying to secure a loan at the best rate or have a business that you are looking to expand via borrowed funds. This is a person who knows and trusts you and could potentially make a difference in whether or not a bank will issue a loan.

Limited Access

Online banks typically keep their fees low and interest rates higher by offering limited services. They may or may not offer debit or credit cards; you may or may not be able to deposit physical cash, and if you can, there may be limits on how much or how often. Every online bank is different, so do your research on the services they offer.

Limited ATM Access

Although many online banks will have a network of ATMs that customers can access, they may not be as easy to track down as ATMs for the major retail banks. It’s worth spending time to see exactly where a digital bank has allied ATMs near your usual haunts, like your home and office, before signing up.

What Is the Difference Between Mobile Banking and Online Banking?

It’s not uncommon for people to use the terms mobile banking and online banking interchangeably, but there is a difference.

•   Mobile banking refers to the kind of banking you can conduct when you download an app and use it on a cellphone or a tablet.

•   Online banking is the sort of banking you do when you connect via a secure WiFi connection, meaning you might be using a laptop to check your balance or transfer funds.

Both of these are ways that you can manage your money without turning up at a physical bank. Wherever you are, as long as you have a secure internet connection, you can pay bills, move money between your checking and savings accounts, and see how much interest you’ve earned, among other things.

Security of Traditional and Online Banks

There is often a misunderstanding about security at banks. People worry, Will my online account be hacked? Are online savings accounts safe? The truth is, traditional banks are no more or less secure than online-only banks. Any bank that is insured by the FDIC guarantees the same amount of insurance in the event that the bank goes under $250,000, regardless of whether the bank is online or not. Digital banks generally tend to offer similar fraud protection programs as bricks-and-mortar banks.

Security typically has more to do with whether you use your debit card only on protected sites, do not access your banking information on a public computer, and avoid accessing private information while on public Wi-Fi networks. Unfortunately, even people who do everything right and take all of the proper precautions still find themselves the victims of some kind of bank fraud. Sometimes, it can only be attributed to bad luck.

How Do I Open An Online Account?

It all depends on the bank, but these banks generally have made it easier than ever to open up accounts. The process can likely all be done online, so you don’t have to sign and return physical paperwork.

Usually, opening a digital bank account requires two steps: First, you open an account at the new bank. To do this, you will have to answer a series of questions, and you will likely need to provide personal identification information like your Social Security number, date of birth, and more.

Next comes funding the online bank account, which can be done with a check or via a funds transfer. Usually, you are able to pull the assets into the new bank account by linking to an existing account you own. Most of the time, the sign-up process can be done in a matter of minutes, and you’ll be ready to start using your digital bank account.

💡 Recommended: What Do You Need to Open a Bank Account Online?

The Takeaway

Whether you call it online banking, mobile banking, or digital banking, the concept of doing all of your keeping your accounts at an online-only bank offers many rewards. You’re likely to earn higher interest and pay fewer fees, for instance. But for those who like banking in person at a branch and having a relationship with the team there, then it may not suit you. Think carefully about what suits your personal financial style best and will keep you on top of your money matters.

If you do think an online bank might be for you, come see what SoFi offers. When you open a new bank account with direct deposit, you’ll enjoy a terrific APY, none of the usual monthly, minimum-balance, and overdraft fees, plus you’ll be able to access your paycheck up to two days early.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOMN18115

Outstanding checks are common for business owners and individuals. They are simply checks that have not yet been cashed or deposited at a financial institution. Since they are still outstanding, the payor (the entity that issued the check) should keep enough cash in their account so they can pay all outstanding checks. The payee, or recipient, should take steps to deposit outstanding checks as quickly as possible to avoid the risk of their becoming void.

To fully answer the question “What are outstanding checks?” there are more details worth learning. This information can help you better manage your financial life and be a savvier consumer. Read on to find out:

•   How outstanding checks work

•   What to do with old checks

•   What risks are associated with outstanding checks.

What Is an Outstanding Check?

Typically, a payor writes a check to a payee, and the payee deposits the check. Funds are transferred into the payee’s account this way. With today’s technology, checks can be cashed without a fee electronically. If you can access your bank account by app, all it takes is a few clicks on your phone.

But with outstanding checks, things don’t follow this flow. An outstanding check is a check that has been issued but not cashed or deposited. It is considered a liability for the issuer until it is redeemed. If outstanding checks aren’t redeemed, they can become void after a certain timeframe, often six months.

An outstanding check can also mean that a check was deposited at a bank but is still going through the process of clearing. This means it is en route to becoming available funds in the payee’s account, but it’s just not quite there yet.

Until it is deposited, outstanding checks are liabilities on the payor’s balance sheet. Small business owners might wonder, “What does an outstanding check mean?” as well as how to deal with it. It can be a challenge, because enough cash must be kept in the account drawn upon to cover outstanding checks until they are cashed. Outstanding checks can complicate accounting because the assumption is that a check gets issued, deposited, and paid. But if it hasn’t been cashed yet, it can throw off bookkeeping.

How Do Outstanding Checks Work?

Once you write a check or sign a check over to someone, the onus is on them to deposit the check. But sometimes, people don’t make a beeline for the bank or use their banking app right away. How often have you received a check, set it aside on your desk, then nearly forgotten about it? It’s not just you.

Business owners know that outstanding checks might take weeks or months to get cashed. Sometimes, checks wind up hanging around uncashed for a while. Or they even get lost.

Typically, though, check cashing is pretty straightforward. A check is simply a document that authorizes a transfer of money from a payor’s account to a payee’s account. When the payee deposits an outstanding check at a bank, a request to move money is initiated. Funds then move between the two accounts. A bank deposits the cash into the recipient’s account once the bank receives the money from the payor’s account. (Cashing a check without a bank account is more challenging, but you still have options to accomplish this.)

So, what is an outstanding check? It’s when the payee neglects to cash or deposit a check (or the check gets lost). This means the check does not clear and does not show on a month-end bank statement. Outstanding checks are a liability for the payee, but once deposited, they are reconciled against the recipient’s account.

A Check I Wrote to Someone Is Outstanding: Now What?

If you wrote a check that is outstanding for more than a few weeks, there are steps you can take to resolve the situation. First, know that outstanding checks expire, often after six months, but sometimes as quickly as 30 or 60 days. Knowing how to stop payment on a check is useful as well if you wish to void an outstanding check. (More on this below.)

Here are more details on managing outstanding checks.

If the Check Is Less Than Six Months Old

•   Track the value of outstanding checks in your account register.

•   Reach out to the payee and ask what happened to the outstanding check.

If the Check Is Older Than Six Months

•   Reach out to the bank to confirm its policy on old or expired checks

•   Issue a stop payment on the outstanding check.

◦   You might have to visit a branch location to make the request, and there could be a fee involved.

◦   Working with the bank to ensure a stale check gets deposited might require time and effort.

◦   Once voided, be sure to mark the old check as voided in your checkbook. Checkbooks can be useful when tracking old checks.

•   Contact the payee about the situation.

◦   Be sure to tell them that you issued a stop payment on the original check.

◦   Work with them to determine another way to be paid.

Do I Need to Write a New Check?

When dealing with outstanding checks, you may wonder if there’s a limit on how long someone has to cash a check. There often is. Knowing when a check expires is an initial step before deciding whether to write a new check. If a check is outstanding for less than six months, you should not write a new one. Contact the payee to find out more about the situation. That also serves as a friendly reminder to have them deposit it. If more than six months have passed, that check may well be expired and considered void. A new check would have to be written or another method of payment could be used.

If you do write a new check, it may be safest to request that the old one be returned or ask for proof that it’s been voided. Otherwise, in rare cases, you might wind up with both the old (outstanding) and the new check being cashed, which would leave you with a financial loss.

A Check Issued to Me Is Outstanding: Now What?

You should take all reasonable steps to cash or deposit outstanding checks. If you wait too long, the check can go stale, and the money might be then considered “unclaimed property” and wind up being handed over to the state. If it has been more than six months, contact the issuer to resolve the matter. If the sticking point is that you don’t have an account into which you can deposit the check, you can easily open a checking account. It can take just minutes to do so online.

Risks of Outstanding Checks

There are many risks to outstanding checks.

•   One of the major ones is that it bounces by the time an attempt is made to deposit it. This is one of the reasons why knowing what to do if a check bounces is important.

•   You may wind up being charged overdraft fees and non-sufficient funds (NSF) fees if the outstanding check is deposited and then bounces.

•   Outstanding checks also become stale and worthless after a certain period.

•   In business bank accounts, outstanding checks can cause hiccups in accounting if not tracked well.

Reasons Why Checks Aren’t Cashed

There are a number of reasons why checks don’t get cashed and wind up being outstanding:

•   Lack of urgency. A person just doesn’t get around to depositing it.

•   Simply forgetting about them or not keeping tabs on them properly.

•   Loss. Checks can be misplaced or even thrown away.

•   Mail and delivery problems that interfere with the check getting to its recipient (this can involve having an old address on file).

Avoiding Outstanding Checks

While there are many risks with outstanding checks, there are simple steps you can take to avoid them.

•   Keeping a balanced checkbook goes a long way toward preventing a check from being forgotten.

•   Maintaining a tidy desk and filing cabinet for important documents like checks can help you deposit funds promptly.

•   If you wrote the check, calling a payee to remind them that a check is outstanding is a wise tactic.

•   Using online bill pay services can help you dodge the headaches that can come with paper checks.

Banking With SoFi

It’s important to know what an outstanding check is and the potential risks that go along with them. Many checks remain outstanding which can cause risks to both the person holding a check and the entity that issued it. Fortunately, with today’s technology and mobile banking capabilities, it’s easier and faster than ever to deposit checks.

SoFi can help you avoid glitches due to outstanding checks. You can sign-up for real-time mobile alerts that notify you when a check hits your account with our mobile banking app. Banking with SoFi means you have access to paper checks and can make no-cost, peer-to-peer (P2P) money transfers to anyone with a US-based bank account right from your phone. What’s more, when you open your accounts with direct deposit, you can earn a competitive APY.

FAQ

Is an outstanding check bad?

Outstanding checks are not bad per se, but it’s generally wise to promptly deposit or cash checks so that they do not expire. Checks that remain outstanding beyond a certain time frame could become void, so if you hold such a check, you might be out of luck if you then wish to deposit it. Also, outstanding checks can make it hard to determine an account’s available balance, which can lead to bounced checks and overdraft charges.

How do you handle an outstanding check?

If you wrote a check and it is still outstanding, you should consider contacting the recipient to confirm they received it. That might give the payee a nudge that they should deposit it. If you possess an outstanding check, it’s good to deposit it as soon as possible to avoid having it go stale.

Is an outstanding check a debit or credit?

A bank’s reconciliation process will subtract the balance of outstanding checks from an account’s balance on a statement. There is no journal entry for this transaction since the checks were recorded when first issued. The bank makes an entry in its general ledger when it voids a check, however. In that case, a debit of cash is entered and a credit back to the issuing account is made to offset the debit. The voided check is removed from the outstanding checks list.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Photo credit: iStock/Tassii
SOBK0522022

Yes. Certificates of deposit (CDs), also known as term deposits or time deposits, are FDIC-insured savings accounts available at most banks. CDs earn interest on the principal deposited for a specific period of time, and that interest is taxable.

CDs come with certain restrictions. For example, you cannot access your money for a fixed period of time (e.g. 3 months, 1 year, 5 years). In exchange, CDs often pay more interest than a regular savings account, though the rates are typically low. In fact, many CD accounts don’t keep up with inflation, so once taxes are paid on the interest earned there may not be much of a return on your investment.

If you’re thinking of buying a CD, it’s important to understand how CDs work and how they are taxed.

What Is a Certificate of Deposit?

A certificate of deposit (CD), also known as a term deposit or time deposit, is a savings account that comes with certain rules and restrictions. The chief difference between a CD and a traditional savings account is that once you deposit funds, you can’t add to the account or withdraw from the account for the entire term of that CD, whether that’s three months or three years. In most cases, if the account holder withdraws the funds before the end of the term, they are charged a penalty.

During that time, however, the funds earn interest (be sure to understand the difference between simple interest and the APY or annual percentage yield), often a higher rate than a traditional savings account.

Are CD accounts taxed? Yes, account holders are taxed on the interest earned. The amount of interest paid depends on the amount deposited and the length of the CD term. Investing in CDs is a fairly conservative endeavor as they are low risk compared to other types of investments. That said, the interest earned on a CD is minimal, and can be reduced by the tax you might pay.

How Do Certificates of Deposit Work?

CDs are guaranteed funds for a bank because the account holder agrees not to withdraw the principal for a certain period (e.g. 6 months, 2 years, 5 years). The bank pays a fixed interest rate to the CD holder in return for using the funds to invest elsewhere to make a profit.

The advantage of a CD vs. a regular savings account with unrestricted withdrawals is that the CD earns a fixed interest rate that can be higher than a regular savings account.

The longer the CD’s term length, generally the higher the interest rate. However, the rate of return is still lower than other investments such as stocks or other riskier investments. Like bonds, CDs are considered relatively safe investments because they are low risk and pay a fixed rate of interest. Also, CD deposits are protected by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA) for up to $250,000 per person.

What Happens If a CD Is Redeemed Early?

Most CDs are subject to penalties if funds are withdrawn early. Each bank will set penalties differently, and they may include loss of principal and loss of interest earned. If the penalty charged by the bank exceeds the interest earned by the CD at the time of withdrawal, some of the principal may be used to make up the difference.

Recommended: How CD Early Withdrawal Penalties Work

What Counts as an Early Withdrawal?

How soon the money is withdrawn during the CDs term is significant. According to federal law, if the principal is redeemed in total within the first six days after depositing the money in a CD, a minimum penalty of at least seven days of simple interest is levied, but the total penalty charged by the bank will likely be more. It is possible to lose all of the earnings on the principal.

How Much Are Early Withdrawal Penalties?

Individual banks determine how much interest to withhold as a penalty for early withdrawals based on the CD’s term. The longer the term, the more interest will be charged. For example, some banks may charge a penalty of six months of interest on an 18-month-term CD. Others may charge a set fee of $25 plus 3% of the amount withdrawn.

Some banks will allow partial withdrawals from a CD, and some do not. Before opening a CD, the account holder should check the early withdrawal conditions set by the bank.

Are Penalties Tax Deductible?

Early withdrawals from CDs may reduce your total tax obligation because the penalty paid can be deducted from your taxes, even if the amount is more than the interest earned. For example, if you earned $100 interest but paid a penalty of $200, you can deduct the $200.

What Is a No-Penalty CD?

No-penalty CDs do exist and are known as liquid CD accounts. These often allow the CD holder to withdraw funds without a penalty within seven days of the initial deposit, after a certain period, or during the term, depending on the bank’s rules. However, the interest earned on these liquid accounts will be lower than regular CD accounts, and the bank may require a higher minimum deposit.

What Happens When the CD Term Ends?

When the CD term is up, some banks will automatically renew the CD. However, the account holder will be notified in case they would rather withdraw the funds and the interest earned.

If the account holder dies, the full face value of the CD is paid to the beneficiary with no early withdrawal penalties if the owner died prior to the maturity date.

How Are Certificates of Deposit Taxed?

The interest earned on a CD is considered income by the Internal Revenue Service (IRS). That applies even if the money is rolled over to a new CD. The interest earned is taxable each year earnings are paid on the CD.

The bank will typically send CD holders a 1099-INT statement for any interest earned over $10, but taxes are due even if the investor doesn’t receive a 1099. The amount of tax you pay will depend on the amount of your earnings and your tax bracket. Also, CDs are taxes as interest income, not as capital gains, which can be a lower tax rate.

Taxes on Short-Term CDs

For a six-month CD purchased in one year, tax on any earnings over $10 will be due for that same year. The exception to this rule is if the CD is in a tax-deferred individual retirement account (IRA) or 401(k) — sometimes called an IRA CD.

If you open an IRA and the money you deposit is below the annual contribution limit, interest earned in a given year may be tax deferred (i.e. not taxed until funds are withdrawn in retirement).

How Is Interest Taxed on CDs?

When a CD matures, and if it is cashed in, only the amount above the initial investment is considered income. Here’s an example,

If you purchase a one-year CD for $15,000 and it pays 1% interest, in one year you will have earned roughly $150 (it’s slightly more with compounding). At maturity, the bank will give you $15,150, your original investment of $15,000 plus the interest of $150. You will only pay tax on the $150, and this is what will be shown on the 1099-INT.

Recommended: How Does Compounding Interest Work?

Preparing to Pay Taxes on a CD

•   Make a schedule of the timing and amount of taxes on your CD.

•   Here’s a formula to estimate the annual tax obligation on your CD interest:

   CD value x CD interest rate x your income tax rate = annual tax obligation

•   If you have CDs in a traditional IRA and you are required to make a required minimum distribution or withdrawal from the IRA, first calculate the amount of the RMD you will have to take that year. Second, calculate the income tax on that RMD.

•   Consider rolling over the RMD to a taxable CD outside of the IRA.

•   Consider setting up CDs that mature in time to make your tax payments. This is called a CD ladder, whereby one CD matures each year in an amount large enough to make the tax and/or RMD payments for that year.

For CDs with a multi-year term, the holder will pay taxes each year on the interest earned that year until maturity.

•   Calculate how much you earned in interest for each year on each CD.

•   Remember that if you own a CD with a three-year term, your account will be credited with interest in each of those three years. You will then owe tax each year even before you cash out or roll over the CD at the end of three years.

•   Check that your calculation matches the amount written on Form 1099-INT each year, notifying you of the amount of earned interest you owe taxes on that year.

The Takeaway

So are CD accounts taxable? In effect yes, because the interest earned can be taxed. The amount of tax due will depend on the amount of earnings and the account holder’s tax bracket.

Certificates of deposit (CDs) are FDIC-insured savings accounts available at most banks. CDs generally earn more interest than a regular savings account, but the rates are typically low and can vary depending on the length of the term and the amount of the deposit. Also, CDs do not keep up with inflation, so once taxes are paid on the interest earned, there may not be much of a return on the investment.

CDs are subject to penalties if funds are withdrawn early. If the penalty charged by the bank exceeds the interest earned by the CD at the time of withdrawal, it’s possible to lose all the earnings on the principal (but these penalties are tax deductible, which may help make up for some of the loss).

If you’re ready to start saving, but you’d like a higher rate, consider opening a new bank account with SoFi. It’s an all-in-one account that blends the features of checking and savings accounts. With the special “vaults” feature you can separate your savings from your spending, earn competitive interest on your total balance, and pay no account fees or monthly fees.

FAQ

Are CD accounts taxed?

Yes. CD holders must pay taxes on any interest earned on a CD.

How much is the tax on a CD?

The amount of tax due will depend on the amount of earnings and the account holder’s tax bracket. CDs are taxed as interest income, not as capital gains, which can be a lower tax rate.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

Photo credit: iStock/pinstock
SOBK0422056