How a bank determines the interest rate on your fixed deposits

Owing to stable returns, Fixed Deposits (FDs) are often considered a go-to option among risk-averse individuals. With this investment instrument, you need to park a certain sum of money at a fixed interest rate and tenor. On maturity, the bank returns you the principal amount in addition to accrued interest.

The interest rate of FDs is fixed at the time of opening and remains independent of market fluctuations. If you are wondering how the Fixed Deposit interest rate is calculated by banks, read on:

Methods to Calculate Interest Rates on FDs

Typically, there are two methods through which banks calculate Fixed Deposit interest rates. The method is decided depending on the deposit amount and the tenor. They are:

1. Simple interest

In this method, the interest rate remains fixed for a said tenor. This is determined by multiplying the annual rate of interest, tenor and principal amount. The formula for simple interest is as follows:

SI = PxRxT/100

Where,

P = Principal

R =Interest rate per annum

T = Tenor

Let us understand this with an example.

Suppose you invest Rs.10,000 at 7% for a period of 5 years. You can calculate interest as:

Step 1: 10,000 x 5 x 7 = 3,50,000

Step 2: 3,50,000 / 100 = 3,500

Thus, the interest you earn for 5 years for that amount is Rs.3,500.

Thus, if you deposit Rs.10,000 through FD for a period of 5 years at an interest rate of 7%, you will earn Rs.13,500 at the end of the tenor.

2. Compound interest

In this method, you earn interest on the principal amount as well as on the interest component. Most banks offer FDs at a compounded interest rate, which is calculated as:

CI = P(1+r/n)^n*t 

Where, 

P = Principal

R = Rate of interest

N = Compound interest frequency

T = Tenor

Let us understand this through an example:

Suppose you invest Rs.10,000 for a period of 5 years at an interest rate of 7%. Your interest breakup will be as follows:

Year 1

First, you need to calculate this using the SI formula, i.e., 10,000 x 1 x 7 / 100 = 700.

So, the interest you earn in the first year is Rs.700.

This amount gets added back to the principal, which becomes Rs.10,700.

So, in the second year, your interest will be calculated on a principal amount of Rs.10,700.

Year 2

In the second year, you will earn interest as follows:

10,700 x 7 x 1 / 100 = 749

Thus, you earn an interest of Rs.749 in the second year. Adding this to your principal amount = Rs.11,449.

Similarly, the interest for the following three years is calculated. However, the calculations mentioned above are given in terms of annual compound interest. Some banks may calculate this even monthly, quarterly or half-yearly. 

Thus, if you are wondering how the Fixed Deposit interest rate is calculated, you can apply the above-mentioned formulae to arrive at your investment returns. However, manual calculations can leave a way for mistakes. In such situations, an FD calculator comes to the rescue. You can resort to this online device, which is easy and free to use. 

Upon calculating returns, you can start investing through FDs through Bajaj MARKETS, which is a diversified marketplace featuring FDs offered by leading banks and financial institutions. 

Things to Consider Before Opting for Fixed Deposits

Apart from knowing how the Fixed Deposit interest rate is calculated, it is also crucial for you to know a few factors that might affect your FD investment. They are:

1. Risk appetite

You should always consider your risk tolerance levels before making an investment. Your risk appetite is unique to you and your financial objectives. Fixed deposits are an excellent financial instrument because they carry little risk and provide guaranteed returns, making them suitable for investors who are risk-averse.

2. Investment horizon

FD tenors can range from 7 days to 10 years Thus, they are ideal for both long-term and short-term investors. So, whether you want to grow your money in a stable and consistent manner for a long time or just park your excess funds in a risk-free savings option that guarantees returns, FDs are a great choice.

3. Financial goals

Your financial goals are another important consideration when making an FD investment. If you need the invested capital right away, consider short-term FDs as a safe place to park your money while also earning guaranteed returns. If you don't need the money right away, consider a long-term FD, which will provide a higher rate of return while keeping your money safe. 

Furthermore, if you require a consistent source of income, consider investing in a non-cumulative fixed deposit that will pay you interest at your specified rate. Otherwise, consider a cumulative fixed deposit to help you get the most out of your fixed deposit investments.

Now that you know how Fixed Deposit interest rate is calculated, you can start your investment journey through this vehicle in an informed manner. However, before proceeding, consider going through the terms and conditions thoroughly.

Also Read: Rising interest on loans: 5 money tips to lower your anxiety

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