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What are Fixed Rate Savings Bonds?

K. Kinsella
K. Kinsella

Fixed rate savings bonds are a type of debt instrument issued by governments or financial institutions, and involve a creditor loaning money to the issuer for a specific period of time in return for fixed interest payments. The interest rates paid on fixed rate savings bonds are usually higher than the rates paid on savings accounts. Bondholders must usually wait for at least a year before redeeming their bonds and, in many instances, bondholders who redeem bonds early incur an interest penalty.

Governments issue savings bonds to raise money for short-term expenses. Funds are raised through taxation to provide bondholders with an eventual return of principal, as well as interest payments. Fixed rate savings bonds normally do not mature until five or 10 years after issuance. The interest paid on government bonds compounds, and the only way that investors can access interest is to redeem the bond.

Businessman with a briefcase
Businessman with a briefcase

Some governments issue fixed rate savings bonds that sell at a discount to par value. The issuer typically sells the bond for half of the face value and, as interest compounds, the bond eventually reaches its actual par value. Many people prefer fixed rate savings bonds to variable rate bonds because they know exactly when the bond will mature, whereas there is no way of knowing how long it will take for a variable rate bond to reach par value.

Banks often issue savings bonds with durations of five years or more. The banks use money raised from selling bonds to finance loans and mortgages. Bondholders can either let the interest payments compound or take interest disbursements on a quarterly or semi-annual basis. When the bond matures, the bondholders can either start a new bond term or redeem the bond.

Fixed rate savings bonds, unlike other types of government and corporate bonds, are non-negotiable and non-marketable. This means that a bondholder cannot sell the bond to another investor, and bond issuers only allow the original owner to redeem the bonds. The only circumstances in which someone other than the named bondholder can redeem a bond is if the bondholder establishes a durable power of attorney or the bondholder dies. A designated power of attorney can conduct financial transactions, including bond redemptions, on behalf of another individual. The heir of a deceased bondholder can redeem a bond if the bondholder named that person as the pay-on-death beneficiary, or if a probate court awards to bond to that person.

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