The great thing about term deposits is the peace of mind you get knowing your money is securely tucked away with an authorised deposit-taking institution. Additionally, as term deposits generally offer a fixed interest rate, you know exactly how much your nest egg will be worth when your account matures.
What determines term deposit rates?
Term deposit rates are influenced by a range of factors, including:
- The cash rate. As the benchmark rate for financial institutions, the cash rate has the biggest influence on interest rates and is moderated by the Reserve Bank of Australia (RBA).
- Market competition. Financial institutions use competitive interest rates to encourage customers to deposit funds with them.
- The investment term. Terms are usually between one month and five years. The general rule of thumb is the longer the term, the higher the interest rate.
How is term deposit interest paid?
Interest on term deposits is typically paid when the account matures. But with longer-term deposits, interest may be paid into your account monthly, quarterly, twice yearly or yearly.
Most term deposits come with simple interest, meaning you’ll only earn interest on your initial deposit and not on your interest. No additional deposits are permitted, either. Some banks pay monthly interest on longer-term deposits and may offer you the option to add your interest back into your term deposit so it can earn compound interest. However, not all banks offer this option.
Once your term deposit matures, your financial institution might give you the option to reinvest the interest you earned back into the term deposit and roll it over, as opposed to simply transferring it to a nominated bank account. Additionally, some financial institutions may offer you access to the interest before maturity, giving you the opportunity to invest the money elsewhere or even pay your interest into a linked transaction account.
» MORE: Term deposit maturity options
How to calculate interest on a term deposit
Before you decide on a term deposit, you should work out exactly how much interest you’ll earn. Divide the annual interest rate by 365 days to get the daily rate. Then find out the number of days in your term deposit investment period (for example, 90 days if your deposit term is three months) and multiply the daily rate by the number of days.
How to find the best term deposit interest rate
Be sure to shop around before deciding on a term deposit. Resist the temptation to settle on one of the big four banks without seeing what else is out there. There are plenty of financial institutions, such as credit unions, with competitive offerings that could give you more bang for your buck.
Factors that may affect the rate
The investment period or term will affect the rate you earn, and the rule of thumb is the longer you lock it in for, the higher the rate.
Accounts with more frequent interest payments may offer a lower interest rate than those that pay annually or at maturity, so you’ll want to check the frequency of the payment.
The amount of your initial deposit will affect the rate, too. For instance, on average, the difference in the rate between a six-month term and a 12-month term can be more than 1%.
Some longer-term deposits come with compound interest but tend to offer a lower rate, so any extra money you make in compound interest will be offset by the lower interest rate.
If you need to access your money early, you may be hit with an early withdrawal fee and an interest rate reduction. Some banks may allow partial withdrawal as long as your account doesn’t dip under a certain amount, which is based on what percentage of the term has elapsed. For instance, if you have a 3% rate on a three-year term deposit but withdraw it early, say in the first two months, the rate could drop to about 0.30%, which probably wouldn’t be the return you were hoping for. As a general rule, the lower the amount or percentage of time elapsed, the higher the reduction will be.
Remember that a term deposit is not really a set-and-forget transaction. Your bank should contact you to let you know the account is due to mature. If you don’t take any action, your money may roll over into a new term deposit with a lower interest rate. However, there will usually be a seven-day cooling-off period following a rollover to allow you to decide whether the new term deposit is right for you. It’s a good idea to keep a record of the date of maturity so you’re prepared.