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A term deposit, also known as a certificate of deposit (CD) or time deposit, is a low-risk, interest-bearing savings account. In most cases, term deposit holders place their funds into an account with a bank or financial institution and agree not to withdraw the funds until the maturity date (the end of the term). The funds can earn interest calculated based on the amount deposited and the term.

This guide explains what a term deposit is in more detail, including:

•   How term deposits work

•   What a time deposit is

•   Different types of term deposits

•   How to open and close a term deposit

•   The pros and cons of terms deposits.

What Is a Term Deposit or Time Deposit?

Time deposit, term deposit, or certificate of deposit (CD) are all words that refer to a particular kind of deposit account. It’s an amount of money paid into a savings account with a bank or other financial institution. The principal can earn interest over a period that can vary from a month to years. There is usually a minimum amount for the deposit, and the earned interest and principal are paid when the term ends.

One factor to consider is that the account holder usually agrees not to withdraw the funds before the term is over. However, if they do, the bank will likely charge a penalty. Yes, that’s a downside, but consider the overall picture: Term deposits typically offer higher interest rates than other savings accounts where the account holder can withdraw money at any time without penalties.

Compared to stocks and other alternative investments, term deposits are considered low-risk (they’re typically insured by the FDIC or NCUA), and the returns are correspondingly conservative.

How Does a Bank Use Term Deposits?

Banks and financial institutions can make money through financing. For example, they likely earn a profit by issuing home, car, and personal loans and charging interest on those financial products. Thus, banks are often in need of capital to fund the loans. Term deposits can provide locked-in capital for lending institutions.

Here’s how many bank accounts work: When a customer places funds in a term deposit, it’s similar to a loan to the bank. The bank will hold the funds for a set time and can use them to invest elsewhere to make a return. Let’s say the bank gives the initial depositor a return of 2% for the use of funds in a term deposit. The bank can then use the money on deposit for a loan to a customer, charging a 6% interest rate for a net margin of 4%. Term deposits can help keep their financial operation running.

Banks want to maximize their net interest margin (net return) by offering lower interest for term deposits and charging high interest rates for loans. However, borrowers may choose a lender with the lowest interest rate, while CD account holders probably seek the highest rate of return. This dynamic keeps banks competitive.

Recommended: Breaking Down the Different Types of Bank Accounts

How Interest Rates Affect Term Deposits

Term deposits and saving accounts in general tend to be popular when interest rates are high. That’s because account holders can earn a high return just by stashing their money with a financial institution. When market interest rates are low, though, people are more inclined to borrow money and spend on items like homes and cars. They may know they’ll pay less interest on loans, keeping their monthly costs in check. This can stimulate the economy.

When interest rates are low (as checking account interest rates typically are), the demand for term deposits usually decreases because there are alternative investments that pay a higher return. For example, stocks, real estate, precious metals, or cryptocurrency might seem more appealing, although these are also higher risk.

The interest rate paid on a term deposit usually depends on the amount deposited and the time until maturity. So, a CD of $10,000 with a maturity date of six months might pay 0.05% annual percentage yield (APY), while a certificate of deposit of $10,000 with a maturity date of five years might pay 0.15% APY. Also, if you have a larger deposit with which to open a CD, you will likely have more options; these may include higher APY earning.

Types of Term Deposits

There are two main types of term deposits: fixed deposits and recurring deposits. Here’s a closer look.

Fixed Deposits

Fixed deposits are a one-time deposit into a savings account. The funds cannot be accessed until the maturity date, and interest is paid only on maturity.

Recurring Deposits

With a recurring deposit, the account holder deposits a set amount in regular intervals until the maturity date. For example, the account holder might deposit $100 monthly for five months. Each deposit will earn less interest than the previous installment because the bank holds it for a shorter period.

In addition to these two types, you may see banks promoting different kinds of CDs, whether they vary by term length or by features (such as penalty-free, meaning you aren’t charged if you withdraw funds early).

Opening a Term Deposit

To open a term deposit account, search online for the best interest rates, keeping in mind how much you want to deposit, how often, and for how long. Most banks will ask you to fill in an online application. Make sure you read and agree to the terms of the agreement. For example, check the penalties that apply if you decide to withdraw your funds early as well as the minimum amount required to earn a certain interest rate.

Closing a Term Deposit

A term deposit may close for two reasons — either the account reaches maturity or the account holder decides to end the term early. Each bank or financial institution will have different policies regarding the penalties imposed for breaking a term deposit. Read the fine print or ask a bank representative for full details.

When time deposit accounts mature, some banks automatically renew them (you may hear this worded as “rolled over” into a new account) at the current interest rate. It would be your choice to let that move ahead or indicate to the bank that you prefer to withdraw your money.

If you want to close a term deposit before the maturity date, contact your bank, and find out what you need to do and the penalties. The penalty will depend on the amount saved, the interest rate, and the term. The fee may involve the loss of some or all of interest earned.

Term Deposits and Inflation

Term deposits may not keep up with inflation. That is, if you lock into an account and interest rates rise over time, your money won’t earn more. You will likely still earn the same amount promised when you funded the account. Also, once tax is deducted from the interest income, returns on a fixed deposit may fall below the rate of inflation. So, while term deposits are safe investments, the interest earned can wind up being negligible. You might investigate whether high-yield accounts or stocks, for instance, are a better option.

Term Deposit Pros

What are a term deposit’s advantages versus regular high yield bank account and other investments? Here are some important benefits:

•   Term deposit accounts are low-risk.

•   CDs or time deposits usually pay a fixed rate of return higher than regular savings accounts.

•   The funds in a CD or deposit account are typically FDIC-insured.

•   Opening several accounts with different maturity dates can allow the account holder to withdraw funds at intervals over time, accessing money without paying any penalties. This system is called laddering.

•   Minimum deposit amounts are often low.

Term Deposit Cons

There are a few important disadvantages of term deposit accounts to note, including:

•   Term deposits can offer lower returns than other, riskier investments.

•   Term deposits and CDs usually have fixed interest rates that do not keep up with inflation.

•   Account holders likely do not have access to funds for the length of the term.

•   Account holders will usually pay a penalty to access funds before the maturity date.

•   A term deposit could be locked in at a low interest rate at a time when interest rates are rising.

Examples of Bank Term Deposits

Here’s an example of how time deposits can shape up. Bank of America is the second-largest consumer bank in the United States, according to the Federal Reserve. As of May 2022, the bank offered a Standard Term CD account and a Featured CD account.

•   The Standard Term CD: A 12-month CD with a minimum deposit of $1,000 pays 0.03%.

•   The Featured CD: A 12-month Featured CD with a minimum deposit of $10,000 pays 0.05%.

As you see, the premium account, with a significantly higher minimum deposit, earns almost twice as much interest as the regular version. Still, neither earns what might be deemed a high rate.

Recommended: How Do You Calculate Interest on a Savings Account?

The Takeaway

Term deposits, time deposits, or CDs are conservative ways to save. Account holders place a minimum amount of money into a bank account for a set term at a fixed interest rate.

The principal and interest earned can be withdrawn at maturity or rolled over into another account. If funds are withdrawn early, however, a penalty will likely be assessed.

While these accounts typically have a low interest rate, they may earn more than standard bank accounts. What’s more, their low-risk status can help some people reach their financial goals.

If you’re looking for security plus a great interest rate, see what SoFi offers. When opened with direct deposit, our Checking and Savings pays a competitve APY. What’s more, we don’t charge any fees, so your money can grow faster.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall. Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

Can you lose money in a term deposit?

Most term deposits or CDs are FDIC-insured, which means your money is safe should the bank fail. However, if you withdraw funds early, you may have to pay a penalty. In a worst-case scenario, this could mean that you receive less money than you originally invested.

Are term deposits and fixed deposits the same?

There is usually no difference between a term deposit and a fixed deposit. They both describe low-risk, interest-bearing savings accounts with maturity dates.

Do you pay tax on term deposits?

With the exception of CDs put in an IRA, any earnings on term deposits or CDs are usually subject to federal and state income taxes. The percentage depends on your overall income and tax bracket. If penalties are paid due to early withdrawal of funds, these can probably be deducted from taxes if the CD or term deposit was purchased through a tax-advantaged individual retirement account (IRA) or 401(k).

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Photo credit: iStock/Olga Trofimova

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.

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With the CD barbell strategy, you invest in short-term and long-term certificates of deposit, and don’t invest any of your money in medium-term CDs — a strategy that can help maximize income and minimize risk.

CDs have different terms, and generally the longer the term, the higher the interest rate. When you invest money in a longer-term CD, you can take advantage of their higher rates. The downside with a long-term CD is that your money is tied up for a longer period of time. You have more liquidity with a short-term CD, but you will typically earn a lower return.

By splitting your money between short-term and long-term CDs, the idea is to capture the best of both worlds. Here’s how a barbell CD strategy works, and whether it makes sense for you.

What Is a Certificate of Deposit (CD)?

A certificate of deposit, or CD is a time deposit account that offers a guaranteed return that’s typically higher than a savings or money market account.

With a CD, you invest a lump sum upfront (called the principal). The bank promises a specified interest rate that you’ll earn for a specific period of time (known as the term). Most CDs are insured against loss by the FDIC (Federal Deposit Insurance Corporation) or the NCUA (National Credit Union Association) for up to $250,000. Certificates of deposit are considered a type of cash equivalent.

CDs typically pay a higher rate than standard deposit accounts because the account holder agrees not to withdraw the funds until the CD matures. If you deposit $5,000 in a 5-year CD, you cannot withdraw the $5,000 (or the interest that you’ve earned) without incurring an early withdrawal penalty until the end of the five years.

If you do need access to your money before the end of the term, you might consider a certificate of deposit loan, where the bank gives you a loan with the money in the CD serving as collateral.

What Is the Certificate of Deposit (CD) Barbell Strategy?

The longer the term of the CD, the higher the interest rate you’ll earn, but the longer your money will be tied up. The CD barbell strategy is one way that you can attempt to get the benefits of both long- and short-term CDs. By dividing your money between long-term and short-term CDs, you will blend the higher interest rates from long-term CDs with the accessibility of short-term certificates of deposit.

In addition to the CD barbell strategy, there are a variety of different strategies for investing in CDs, including the bullet strategy and the CD ladder strategy. So if you’re wondering where to store short term savings, you have several different options to choose from.

Real Life Example of the CD Barbell Strategy

If you want to start investing in CDs and are interested in learning more about the CD barbell strategy, here is one example of how it could work. Say you have $10,000 that you want to invest using the CD barbell strategy.

•   You invest $5,000 in a 3-month CD earning 0.50%

•   You invest $5,000 in a 5-year CD earning 2.50%

Your total return would be 1.50% (the average of 0.5% and 2.5%). That’s less than you would get if you put all of your money in a long-term CD, but more than if you put it all in a short-term CD. Depending on your financial goals, you can adjust the terms of your CDs and the amount you put in each half of the barbell.

Typically with the CD barbell strategy, when your short-term CD expires, you’ll take the proceeds and reinvest it in a new short-term CD.

Benefits of the CD Barbell Strategy

Here are a few of the benefits of the CD barbell strategy:

Higher Returns Than Investing Only in Short-Term CDs

Because half of your money is invested in long-term CDs that pay a higher return, you’ll get a higher return than if you invested only in short-term CDs. This can make it a viable investment strategy if you need access to some of your money but also want higher returns.

More Liquidity Than Investing Only in Long-Term CDs

Another benefit of the CD barbell strategy is that you have easier access to your money than if you invested only in long-term CDs. Half of your money is in short-term CDs, which means that if you need access to your money after a couple of months, you can withdraw the money in your short-term CD when it matures without penalty.

Drawbacks of the CD Barbell Strategy

Here are a few of the drawbacks of the CD barbell strategy:

Excludes Medium-Term CDs

The barbell CD strategy focuses solely on short-term and long-term CDs, excluding medium-term CDs. Depending on your financial situation, you might find it worthwhile to include medium-term CDs as part of your investment strategy.

Ties Up Some of Your Money

When you invest in a long-term CD that won’t mature for several years, you won’t have penalty-free access to that money until the end of the CD’s term. While long-term CDs do usually come with higher returns than CDs with shorter terms, you need to make sure that you won’t have a need for that money until the CD matures.

Barbell CD Strategy vs CD Laddering

Barbell CD Strategy	CD Laddering
Includes only short-term and long-term CDs	Uses short-term, medium-term, and long-term CDs
Insured by the FDIC or NCUA up to $250,000	Insured by the FDIC or NCUA up to $250,000
You’ll have access to some of your money each time your short-term CD expires	Access to your money varies depending on the terms of the CDs you ladder with

When Should I Use a Certificate of Deposit Strategy?

If you decide you need a long-term savings account, you might want to consider a certificate of deposit strategy like the CD barbell strategy.

CDs with different terms come with different interest rates, so there can be advantages to splitting up your money. Rather than putting all of your savings into one CD, you can distribute your money to a few different CDs as a way to diversify your risk and reward.

The Takeaway

CDs come with different lengths or terms, and the longer the term, usually the higher the interest rate that you’ll earn. A CD barbell might make sense if you want the benefit of having some of your money in a higher-interest CD, while keeping the rest of it more liquid (although at a lower rate) — hence the barbell analogy.

Using a CD strategy like the CD barbell strategy is one way to capture some of the higher returns with long-term CDs while still being able to access some of your money by using shorter-term CDs as well. You’ll also have your money tied up for a longer period of time, so there is a tradeoff that you’ll need to consider.

If you’re looking for better interest rates for your cash while maintaining easy access to your money, you might consider a SoFi high-yield bank account. Eligible account holders can earn a competitive APY if you sign up for direct deposit. Also, SoFi doesn’t charge account fees or management fees.

Open a SoFi Checking and Savings account today!

FAQ

Why is it called a barbell strategy?

The CD barbell strategy is so named because you are investing in CDs at either end of the spectrum of possible terms, with nothing in the middle. This is similar to the shape of a barbell that has weights on either end but nothing in the middle.

Does the CD barbell strategy make more money than CD laddering?

With CD laddering, you usually invest an equal amount of your money in CDs that mature each year. Which strategy makes more money will depend on exactly how you divide your money into different CD terms, as well as how interest rates change over the life of your CD strategy.

Does the CD barbell strategy make more money than the bullet CD strategy?

The bullet CD strategy is an investment strategy where you buy CDs that all mature at the same date. Which of these two CD strategies makes more money will depend on a couple of factors. The first is how interest rates change over time, and the second is exactly how you divide up your investments.

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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/hachiware
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A growth savings account is a savings account that earns a significantly higher rate of interest than a standard saving account. This enhanced interest rate means your money will grow faster, which sounds of course like a good thing.

But are these accounts always a good bet? Important points to consider are:

•   What is a growth savings account?

•   How do growth savings accounts work?

•   The pros and cons of a growth savings account

•   How to open a growth savings account.

What Is a Growth Savings Account?

So, what is a growth savings account? Growth savings accounts are similar to regular savings accounts, except they tend to earn more, even 20 times as much, interest than traditional savings accounts. Depositing money in a growth savings account (which may also be called a high-yield savings account) makes it easier to grow savings safely, while keeping those funds accessible.

You may get the best interest rate on a growth savings account at an online bank or credit union versus a traditional, or bricks-and-mortar, bank. However, even at their best, these savings accounts typically don’t have the very high growth of, say, a well-chosen stock portfolio, the kind that could have you living off investment interest.

How Do Growth Savings Accounts Work?

Growth savings accounts function in a similar manner to regular savings accounts. You open the account, put some funds in, and can continue to add to the money as you like, all the while earning interest. The difference is you’ll earn more interest, thanks to their higher rates. This may make it one of the more appealing places to put your cash, especially when saving for short- or medium-term goals, such as building up an emergency fund or taking a European vacation.

As you shop for a growth savings account, you’ll likely find a broad range of rates. Odds are a traditional bank will offer an interest rate well below 1.00% (perhaps 0.02%) at press time. An online bank with growth savings accounts may offer rates of 1.00% or more.

Worth noting: Any interest earned in a growth savings account or a regular savings account may need to be reported as taxable income.

Also, at some financial institutions, you may be limited to only six withdrawals or transfers a month, as is the case with standard savings accounts. For each following withdrawal, you could face a fee or even have your savings account closed or converted into a checking account. A number of banks have relaxed this rule; check with yours to see if they still cap the number of withdrawals per month.

Pros of a Growth Savings Account

Here are a few examples of advantages that come with opening a growth savings account.

Higher Interest Rates

Because growth savings accounts can offer higher interest rates, the money held in a growth savings account tends to grow faster than money held in traditional savings accounts that earn lower interest rates. When determining what is a good interest rate, also look into minimum balances. You may see that the more money you put on deposit, the higher the rate you earn can be.

Accessible Form of Growth

Keeping money in a savings account is a great way to earn interest. It also means your money stays very accessible, which wouldn’t be the case if you invested in the stock market or opened a certificate of deposit (CD), which should be left untouched for a specific term.

Good Way to Build an Emergency Fund

Because these funds are fairly accessible, a growth savings account is a great place to build an emergency fund. That way, the emergency fund can continue to grow until it might be needed.

Cons of a Growth Savings Account

There are also some downsides to growth savings accounts worth keeping in mind before opening one.

Limited Growth Opportunity

Yes, growth savings accounts do earn more interest than traditional savings accounts. However, when considering your long-term savings options, there may be more strategic investments that can enhance growth. If, for instance, you’re saving for retirement, which is a few decades away, you might take a look at the stock market for growth.

Withdrawal Limits

Growth savings accounts generally provide easier access to funds than keeping money in investments. That said, you may only be able to make six withdrawals or transfers per month, or else you risk running into fees or having your account closed or converted to a checking account. Check, though, with your bank about whether this six-transaction limit still holds true. Many financial institutions have abandoned this guideline over the last couple of years.

Earnings Are Taxable Income

The interest earned in a growth savings account can count as taxable income. Compare this to the growth that occurs in a Roth Individual Retirement Account (IRA). There, you won’t pay any income tax on investment earnings.

Pros of Growth Savings Accounts	Cons of Growth Savings Accounts
Higher interest rates	Accessible form of growth
Good way to build an emergency fund	Limited growth opportunity
Possible withdrawal limits	Earnings are taxable income

Recommended: What is a Roth IRA and How Does it Work?

Choosing a Growth Savings Account

When you’re looking for ways to earn more interest on your money, a growth savings account might be a good option. Shop around to find the best fit for your needs. Here are a few factors to keep in mind when looking for a new growth savings account:

•   Interest rates

•   Minimum balance requirements

•   Fees

•   Account features

•   Mobile app

•   Other product and service offerings

It’s important to note that a lot of growth savings accounts come from online banks that don’t have in-person banking locations. Keep that in mind if you prefer to manage your account in-person.

How to Open a Growth Savings Account

While each banking institution will have its own process, opening a growth savings account typically includes the following steps:

•   Fill out the application. When filling out a growth savings account application, you’ll usually provide details like your name, Social Security number, proof of address (say, from a utility bill), and government-issued photo ID.

•   Choose the account type. There may be different savings account types, such as an individual account or a joint account (to share with a spouse or family member). Select the kind that’s right for your needs.

•   Designate beneficiaries. It’s important to choose a beneficiary for your growth savings account, just as you might select a beneficiary for a 401(k) plan. This is the person who would receive the account’s funds if your were to become incapacitated or pass away.

•   Deposit funds. Some banks require a minimum initial deposit, so you may need to make that deposit to open the account.

•   Create login information. If the growth savings account is set up through an online bank, it will be necessary to create login information such as a username and password for the online account. Be sure to create a complex password with at least one capital letter, numbers, and symbols.

While there may be another step or two in some situations, that’s how to open a bank account.

The Takeaway

Everyone wants to earn more interest on their savings account. Growth savings accounts can do just that vs traditional savings accounts since they tend to have higher interest rates. These accounts can be a good way to increase the funds in your savings faster. They are not, however, for everyone nor for all situations. In some cases, investing can help earn more money on savings and help you achieve long-term financial goals.

If you are looking for a new growth savings account, see what SoFi offers. We’re dedicated to helping you bank smarter. Here’s a great example: When you open a new bank account online with direct deposit, you’ll earn a super competitive 4.60% APY and pay zero account fees. That means your money grows faster and won’t be eroded by miscellaneous charges. You’ll also get access to your paycheck two full days early.

If you are looking for a new growth savings account, see what SoFi offers. We’re dedicated to helping you bank smarter. Here’s a great example: When you open a new bank account online with direct deposit, you’ll earn a competitive APY and pay zero account fees. That means your money can grow faster and won’t be eroded by miscellaneous charges. You’ll also get access to your paycheck two full days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall. Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

How do growth savings accounts work?

Growth savings accounts function similarly to traditional savings accounts. The only difference between these account types is that growth savings accounts tend to have higher interest rates.

What does “growth account” mean?

A growth account — also known as a high-yield account — offers a higher interest rate than traditional savings accounts. This higher interest rate leads to more growth on deposited funds.

How much interest does a growth savings account earn?

Interest rates change all the time, so it’s hard to nail down an exact number on what to expect with a growth savings account. That being said, growth savings accounts typically offer an annual percentage yield (or APY) of 1.00%, and sometimes even more than 2.00%.

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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.

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A zero-coupon certificate of deposit or zero-coupon CD is a type of CD that’s purchased at a discount and pays out interest at maturity. Zero-coupon CDs can offer higher yields than standard CDs for investors who have the patience to wait until maturity to collect their original deposit and the interest earned.

Zero-coupon certificates of deposit are similar to bonds, in that both are considered low-risk, fixed-income instruments, but they serve different purposes in a portfolio. Understanding how a zero-coupon CD works can make it easier to decide if it’s a good investment.

What Is a Zero-Coupon CD?

To understand zero-coupon CDs, let’s recap how a certificate of deposit works. A CD account, also referred to as a time-deposit or term-deposit account, is designed to hold money for a specified period of time. While the money is in the CD, it earns interest at a rate determined by the CD issuer — and the investor cannot add to or withdraw from the account.

CDs are FDIC or NCUA insured when held at a member bank or credit union. That means deposits are insured up to $250,000.

CDs are some of the most common interest-bearing accounts banks offer, alongside savings accounts and money market accounts (MMAs).

A zero-coupon certificate of deposit does not pay periodic interest. Instead, the interest is paid out at the end of the CD’s maturity term. This can allow the purchaser of the CD to potentially earn a higher rate of return because zero-coupon CDs are sold at a discount to face value, but the investor is paid the full face value at maturity.

Recommended: CD Loans, Explained

By comparison, traditional certificates of deposit pay interest periodically. For example, you might open a CD at your bank with interest that compounds daily. Other CDs can compound monthly. Either way, you’d receive an interest payment in your CD account for each month that you hold it until it matures.

Once the CD matures, you’d be able to withdraw the initial amount you deposited along with the compound interest. You could also roll the entire amount into a new CD if you’d prefer.

Remember: Withdrawing money from a CD early can trigger an early withdrawal penalty equal to some or all of the interest earned.

How Do Zero-Coupon CDs Work?

Ordinarily when you buy a CD, you’d deposit an amount equal to or greater than the minimum deposit specified by the bank. You’d then earn interest on that amount for the entirety of the CD’s maturity term.

With zero-coupon CD accounts, though, you’re purchasing the CDs for less than their face value. But at the end of the CD’s term, you’d be paid out the full face value of the CD. The discount — and your interest earned — is the difference between what you pay for the CD and what you collect at maturity. So you can easily see at a glance how much you’ll earn from a zero-coupon CD investment.

In a sense, that’s similar to how the coupon rate of a bond works. A bond’s coupon is the annual interest rate that’s paid out, typically on a semiannual basis. The coupon rate is always tied to a bond’s face value. So a $1,000 bond with a 5% interest rate has a 5% coupon rate, meaning a $50 annual payout until it matures.

Real World Example of a Zero-Coupon CD

Here’s a simple example of how a zero-coupon CD works. Say your bank offers a zero-coupon certificate of deposit with a face value of $10,000. You have the opportunity to purchase the CD for $8,000, a discount of $2,000. The CD has a maturity term of five years.

You wouldn’t receive any interest payments from the CD until maturity. And since the CD has a set term, you wouldn’t be able to withdraw money from the account early. But assuming your CD is held at an FDIC- or NCUA-member institution, the risk of losing money is very low.

At the end of the five years, the bank pays you the full $10,000 face value of the CD. So you’ve received $400 per year in interest income for the duration of the CD’s maturity term — or 5% per year. You can then use that money to purchase another zero-coupon CD or invest it any other way you’d like.

Tips When Investing in a Zero-Coupon CD

If you’re interested in zero-coupon CDs, there are a few things to consider to make sure they’re a good investment for you. Specifically, it’s important to look at:

•   What the CD is selling for (i.e., how big of a discount you’re getting to its face value)

•   How long you’ll have to hold the CD until it reaches maturity

•   The face value amount of the CD (and what the bank will pay you in full, once it matures)

It’s easy to be tempted by a zero-coupon certificate of deposit that offers a steep discount between the face value and the amount paid out at maturity. But consider what kind of trade-off you might be making in terms of how long you have to hold the CD.

If you don’t have the patience to wait out a longer maturity term, or you need the money in the shorter term, then the prospect of higher returns may hold less sway for you. Also, keep in mind what kind of liquidity you’re looking for. If you think you might need to withdraw savings for any reason before maturity, then a standard CD could be a better fit.

Comparing zero-coupon CD offerings at different banks can help you find one that fits your needs and goals. You may also consider other types of cash equivalents, such as money market funds or short-term government bonds if you’re looking for alternatives to zero-coupon CDs.

Recommended: How to Invest in CDs: A Beginner’s Guide

Pros of Zero-Coupon CDs

Zero-coupon CDs have some features that could make them more attractive than other types of CDs. The main advantages of investing in zero coupon certificates of deposit include:

•   Higher return potential than regular CDs

•   Guaranteed returns, since you’re unable to withdraw money before maturity

•   Suited for longer-term goals

•   Can be federally insured

Zero-coupon CDs are low-risk investments, which can make them more appealing than bonds. While bonds are considered low-risk investments generally, if the bond issuer defaults, then you might walk away from your investment with nothing.

A zero-coupon certificate of deposit, on the other hand, does not carry this same default risk because your money is insured up to $250,000. There is, however, a risk that the CD issuer could “call” the CD before it matures (see more in the next section).

Cons of Zero-Coupon CDs

Every investment has features that may be sticking points for investors. If you’re wondering what the downsides of zero-coupon CDs are, here are a few things to consider:

•   No periodic interest payments

•   No liquidity, since you’re required to keep your money in the CD until maturity

•   Some zero-coupon CDs may be callable, which means the issuer can redeem them before maturity, and the investor won’t get the full face value

•   Taxes are due on the interest that accrues annually, even though the interest isn’t paid out until maturity

It may be helpful to talk to your financial advisor or a tax expert about the tax implications of zero-coupon CDs. It’s possible that the added “income” from these CDs that you have to report each year could increase your tax liability.

How to Collect Interest on Zero-Coupon CDs

Since zero-coupon CDs only pay out at interest at the end of the maturity term, all you have to do to collect the interest is wait until the CD matures. You can direct the bank that issued the CD to deposit the principal and interest into a savings account or another bank account. Or you can use the interest and principal to purchase new CDs.

It’s important to ask the bank what options you’ll have for collecting the interest when the CD matures to make sure renewal isn’t automatic. With regular CDs, banks may give you a window leading up to maturity in which you can specify what you’d like to do with the money in your account. If you don’t ask for the money to be out to you it may be rolled over to a new CD instead.

How to Value Zero-Coupon CDs

The face value of a zero-coupon CD is the amount that’s paid to you at maturity. Banks should specify what the face value of the CD is before you purchase it so you understand how much you’re going to get back later.

In terms of whether a specific zero-coupon CD is worth the money, it helps to look at how much of a discount you’re getting and what that equates to in terms of average interest earned during each year of maturity.

Purchasing a $10,000 zero-coupon CD for $8,000, for example, means you’re getting it at 20% below face value. Buying a $5,000 zero-coupon CD for $4,500, on the other hand, means you’re only getting a 10% discount.

Of course, you’ll also want to keep the maturity term in perspective when assessing what a zero-coupon CD is worth to you personally. Getting a 10% discount for a CD with a three-year maturity term, for example, may trump a 20% discount for a five-year CD, especially if you don’t want to tie up your money for that long.

The Takeaway

Investing in zero-coupon CDs could be a good fit if you’re looking for a low-risk way to save money for a long-term financial goal, and you’d like a higher yield than most other cash equivalents.

Zero-coupon CDs are sold at a discount to face value, and while the investor doesn’t accrue interest payments annually, they get the full face value at maturity — which often adds up to a higher yield than most savings vehicles. And because the difference between the discount and the face value is clear, zero-coupon CDs are predictable investments (e.g. you buy a $5,000 CD for $4,000, but you collect $5,000 at maturity).

As with any investment, it’s important for investors to know the terms before they commit any funds. For example, zero-coupon CDs don’t pay periodic interest, but the account holder is expected to pay taxes on the amount of interest earned each year (even though they don’t collect it until they cash out or roll over the CD).

If you’re eager to earn a higher rate on your savings, you’ve got a lot of options — including the new high-yield bank account with SoFi. With SoFi, you don’t pay management fees or account fees, and you can earn a competitive APY.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall. Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

What is a coupon on a CD?

The coupon on a CD is its periodic interest payment. When a CD is zero coupon, that means it doesn’t pay out interest monthly or annually. Instead, the investor gets the full amount of interest earned paid out to them when the CD reaches maturity.

Is a certificate of deposit a zero-coupon bond?

Certificates of deposit and bonds are two different types of savings vehicles. While a CD can be zero-coupon the same way that a bond can, your money is not invested in the same way. CD accounts also don’t carry the same types of risk that bonds can present.

Are CDs safer than bonds?

CDs can be safer than bonds since CDs don’t carry default risk. A bond is only as good as the entity that issues it. If the issuer defaults, then bond investors can lose money. CDs, on the other hand, are issued by banks and typically covered by FDIC insurance which can make them safer investments.

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Photo credit: iStock/Joyce Diva

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.

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.

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Suppose you’re one of the lucky few who have substantial savings, built an emergency fund, and are well on your way to a healthy retirement portfolio. In that case, it may be time to think about diversifying your financial portfolio. An investment property may be a solid option to do that.

Real estate investing can help diversify your existing investment portfolio and bring an additional income stream. But before taking the plunge to invest in real estate, here’s what you need to know about investment properties and how to invest in this asset class.

What is an Investment Property?

An investment property is a piece of real estate purchased to earn a return on the investment through rental income or the property’s future resale.

Usually, an investment property differs from an investor’s primary residence or a second home. It can be more challenging for investors to secure financing for an investment property because lenders see it as riskier than a primary residence.

Investors often treat property as a long-term investment. Over a given period, investors can benefit from a stream of rental income and capital appreciation, where the value of a property increases over time.

Most investors get into real estate investing with this long-term time horizon, but some investors treat investing in property as a short-term trade. Investors do this by house flipping, which is when real estate is purchased, renovated, and sold for profit in a short amount of time.

Types of Investment Properties

Residential real estate is a type of property used for people to live in, like single-family homes, apartments, townhouses, and more. Most people think of residential real estate when investing in property.

💡 Recommended: Investing in Single Family vs. Multi Family Houses

However, that is just one type of investment property. Other types of investment properties include:

•  Commercial: Commercial real estate is a term used to describe a piece of land or property used for business purposes. Commercial real estate can include office buildings, warehouses, retail space, large apartment developments, etc. While less common for individual investors, commercial real estate may still be an attractive investment that offers higher rents than residential property, though with increased costs.

•  Mixed-use: A mixed-use property can be used for both commercial and residential purposes. For instance, a building may have a retail storefront on the main floor, while the upper portion of the structure consists of residential apartments or condos.

Who Is an Investment Property Right For?

An investment property is usually a good fit for those interested in earning rental income or owning an appreciating asset. Investing in property can be a way to diversify a financial portfolio, combining it with a mix of stocks, bonds, and other assets.

Additionally, some people invest for the tax benefits associated with real estate investment, while others invest for the ability to build equity in a property.

No matter your reason for investing in real estate, it is vital to research and understand the risks and potential rewards associated with this type of investment.

Pros of Investing in Property

Here are some of the advantages of investing in property. However, these advantages are not guaranteed; investors must research properties and real estate markets to increase the odds of generating returns.

Potential for High Returns

If the real estate you own increases in value over time, you can sell it for a profit. However, this price appreciation isn’t guaranteed.

Passive Rental Income

Investing in real estate can be a way to generate relatively passive income. Whether you invest in residential or commercial real estate, you can rent out your space to tenants and receive regular rental income.

Hedge Against Inflation

Real estate investments may protect against inflation. When the prices of goods and services rise, home values and rents typically increase. Investment properties can therefore provide you with increasing monthly income and appreciation to help protect you when consumer prices are going up.

Potential Tax Advantages

Investing in real estate comes with tax benefits. You can deduct several expenses associated with owning an investment property from your taxes, including your property taxes, mortgage interest, and other expenses.

Cons of Investing in Property

Like any investment, there are potential downsides to investing in property.

High Upfront Costs

Directly investing in property generally requires higher upfront costs than primary residences. Lenders usually require higher down payments and interest rates for investment properties. This makes it difficult for some people who don’t have the initial capital to invest in a property.

High Maintenance Costs

Maintaining a property can be expensive and time-consuming, and it is essential to factor in these costs when considering an investment.

Illiquidity

Real estate isn’t a liquid asset. It could be complicated if you want to sell the property, and you may not be able to sell the property at the price you want.

Real Estate Market Risks

The real estate market can be volatile, and there is always the risk that your investment may not perform as well as you hoped. It’s important to do market research to make sure your investment property is in a location that may experience price increases.

How to Invest in Property

Rental Properties

Purchasing a residential investment property to rent out to tenants is a popular way to invest in property. This strategy allows investors to reap the benefits of generating rental income and price appreciation.

Before you directly invest in a property, it’s important to determine how much you have to spend on this property upfront. Also, it would be best if you have the time to take care of it or have the means to employ someone else to maintain the property.

It’s often beneficial to look in neighborhoods or areas you are familiar with to limit surprises down the line. You may also want to consider neighborhoods where experts think a property is likely to increase in value.

Real Estate Investment Trust (REIT)

Buying and selling the shares of real estate investment trusts (REITs) is one of the easier ways to invest in real estate. With a REIT, an investor buys into a piece of a real estate venture, not the whole thing. There’s less responsibility and pressure on the shareholder when compared to purchasing an investment property.

When a person invests in a REIT, they’re investing in a real estate company that owns and operates anything from malls, office complexes, warehouses, apartment buildings, mortgages, etc. It’s a way for someone to add a diverse mix of real estate investments to their portfolio without developing real estate.

In addition to diversification, earning consistent dividends can be a compelling reason for investors to get involved with REITs. REITs are required by law to pay at least 90% of their income in dividends. The REIT’s management can decide to pay out more than 90%, but they can’t drop below that percentage.

Many, but not all, REITs are registered with the SEC (Securities and Exchange Commission) and can be found on the stock market, where they’re publicly traded. Investors can also buy REITs registered with the SEC but are not publicly traded.

💡 Recommended: Pros & Cons of Investing in REITs

Interest Rates on Investment Properties

Lenders treat investment property loans differently because people are more likely to default on an investment property loan than on a primary residence mortgage.

Typically, lenders will charge a higher interest rate on an investment property than on an owner-occupied property. So if the rate was at 5% for your primary home mortgage, you might have a 6% to 8% interest rate on your investment property mortgage.

Lenders often require at least a 20% down payment to purchase an investment property. This down payment minimum may be higher, depending on the borrower’s credit score and savings.

The Takeaway

Adding an investment property to your financial portfolio can be a good option to build wealth. However, real estate investments come with a lot of work, especially if you decide to invest directly in a property; not everyone is cut out to be a landlord.

Fortunately, investors don’t have to invest directly in real estate or resort to house flipping to get exposure to real estate. Investors can invest in various publicly-traded REITs to benefit from their potential share price appreciation and regular dividends. And with the SoFi Invest® online trading platform, investors can trade stocks and exchange-traded funds (ETFs) for as little as $5.

See how a SoFi Invest account can help you build wealth.

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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.

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