# How to get better returns on fixed deposits by learning how interest rates Work

As your returns on a fixed deposit are assured, you can compute the amount you will earn at maturity beforehand. Knowing how your FD interest rate affects your principal will help you make better investment choices and enjoy more handsome returns. So, here’s a rundown on how interest rates work on a fixed deposit.

Interest is compounded

In basic terms, compounding interest allows you to earn interest on interest. This means you earn substantially more than what you would have earned via simple interest. Each year, your FD interest earned in that year is reinvested with the principal, thus letting you earn increasing amounts as the tenor increases.

Consider this example to understand how compound interest works. Say you invest a sum of Rs.1 lakh in a fixed deposit offering you a Fixed Deposit interest rate of 8% compounded annually for 3 years. After one year, the amount of interest you earn is Rs.8,000. This is then reinvested for the next period. Thus, for the next year, you earn interest on the amount of Rs.1,08,000. On the third year, your interest is earned on Rs.1,16,640. The same process continues, and at maturity, you take back Rs.1,25,971.20.

Returns vary with compounding frequency

Since the interest accrued is reinvested, you gain higher returns with an increasing compounding frequency. For a fixed deposit compounded yearly, the interest is reinvested every 12 months and for an FD compounded quarterly, the interest is reinvested every 4 months.

Take a look at the returns you get on Rs.5 lakh invested in an FD earning interest at a rate of 8.50% for 5 years with these different compounding frequencies.

See also  PayPal Credit Review - What Is It and How to Use?

Yearly: Rs.7,51,829

Half-yearly: Rs.7,58,108

Quarterly: Rs.7,61,399

Monthly: Rs.7,63,650

Now that you know the details of your FD interest calculations, take a look at some variables that affect the FD interest rate you obtain.

Principal amount

Often, interest rates are determined by the amount you invest. Financiers generally have slabs that link FD rates to the principal invested. For example, you may obtain a fixed deposit rate of 7.25% for deposits less than Rs.2 crore and 7.50% for deposits above this sum with certain issuers. Bajaj Finance, for instance, offers you a soaring interest rate of up to 8.75% on an amount as low as Rs.25,000.

Investment tenor

FD interest rates are closely linked to the investment tenor. They normally increase and reach a maximum at 36 months or 3 years. Post this term, they could remain the same, or even drop. To illustrate, your issuer may offer you an interest rate of 8.15% for a 24-month tenor and an 8.75% interest rate for a 36-month tenor.

Payout frequency

Issuers give you the option of taking back your returns at maturity or earning regularly via frequent interest payouts. Depending on your payout frequency, you may witness an FD rate drop as financiers are left with less liquidity as your payout frequency increases. For instance, you may obtain an FD interest rate of 7.77% for quarterly payouts and a rate of 7.72% for monthly payouts.

Financier

The ROI varies from one issuer to the next. This is why it is imperative that you make a smart Fixed Deposit investment with a top NBFC like Bajaj Finance. Here, new customers get fixed deposit rates as high as 8.75% and senior citizens can earn up to 9.10% interest rate. Additionally, existing customers profit from a 0.25% hike on FD renewal.