The inside story on term deposits

Term deposits might come across as a very simple product, but that doesn’t mean you should take a ‘one size fits all’ approach when selecting one. Banks can have dozens of different term deposits, and each one can lead to different interest returns.

One of the biggest differences between term deposits is the length of the term.

What is a term?
The ‘term’ in term deposits is the fixed amount of time your money is deposited with that financial institution. These terms also come with a fixed rate of interest, which as we’ll explain in more detail, vary depending on:

  • the length of the term
  • how often interest is paid (e.g. quarterly, annually, at maturity, etc.)
  • how much you’re depositing
  • whether the interest is compounded or not.

Whatever term you choose, most term deposits require you to lock this money away for the entire time. If you need to access it early, you’ll typically have to wait up to 31 business days and possibly be hit with an exit fee and a reduction in your interest rate.

What terms are available?
Each ADI (authorised deposit-taking institution) that offers term deposits will have different terms on offer. Some will offer only a few, while others will provide a huge variety of options.

Term deposits are generally available in the following terms, from shortest to longest: one month, two months, three months, six months, nine months, one year, two years, three years, four years, five years.

Typically, ‘short-term deposits’ last for less than one year, while anything over a year is classified as a ‘long-term deposit’. It is possible to get term deposits for up to seven years, but these are less common.

You may choose for your interest to be paid at maturity or into your bank account at regular intervals (e.g. monthly, quarterly, semi-annually, annually), but keep in mind most providers have lower rates on term deposits that pay interest regularly.

A small number of term deposits also allow interest to compound if you choose for the interest to be paid at maturity. As at January 2019, only eight providers in Australia offered compounding interest.

Of these, most compound interest annually, although there are some that offer semi-annual, quarterly and monthly compounding options. But does this result in greater returns?

Yes, so long as the interest rate isn’t lower than the non-compounding option.

Some providers will have reduced interest rates on term deposits that allow compounding interest, because a compounding term deposit will earn significantly more interest than a non-compounding term deposit with the same interest rate.

How the different terms affect your interest
Longer term deposits generally offer higher interest rates than shorter ones, although this isn’t always the case. Check some of the smaller institutions and you may find better rates.

Case study: Different term deposit terms
Three separate people have $10,000 to invest in a non-compounding term deposit at the same bank.

Person 1 wants to invest in a short-term term deposit for three months, which gives her an interest rate of 1.8 per cent per annum. She will earn $45.

Person 2 wants to invest in a one-year term deposit, which is offering 2.2 per cent per annum. She will earn $220.

Person 3 has longer-term ambitions and puts her money away for five years at 3.2 per cent per annum. She will earn $1600.

Should you go for a short or long-term deposit?
Short and long-term deposits both have their benefits for different reasons. Long-term deposits obviously provide a much larger sum of interest for the same amount of money, with or without compounding interest. But long-term deposits also require you to not touch this money for the entire term, unless you want to cop a reduced interest rate and a potential break fee. Two to five years is a long time to be without a substantial sum of money, and if you were to ever need it, you’d lose significant interest.

Also, by locking yourself into a long-term deposit, you run the risk of missing out on interest rate rises over that term. For instance, 3.4 per cent per annum may sound good in 2019, but what if in three years’ time the average savings account is paying five per cent per annum and you’re still stuck with 3.4 per cent per annum for another two years? Of course, interest rates could also drop over this time, but banks generally price their term deposit rates based on their in-house economist’s interest rate forecasts.

But having this money locked away long term can also be a blessing. A lot of term deposit users prefer not being able to access the money because it forces them to save. This is different to a savings account where money can be withdrawn at will. Long-term deposits don’t give you the option of losing willpower!

Short-term deposits, on the other hand, generally earn less interest due to the lack of time, but can still be a quick and easy way to earn a decent amount of interest. They can be good for short-term savings goals such as holidays or Christmas presents. You just have to weigh up what you’re investing for, and whether you’re willing to part with the money for a fixed period of time.

When considering how long to lock away your money, ask these questions:

  • Will you be able to go without the money for the full term?
  • Do economists expect interest rates to fall or remain stable over the term?
  • Will you be happy to forgo the potentially higher long-term returns of investing in shares and bonds for less risk?

If you answered no to any of these questions, perhaps you may want to consider a shorter-term deposit or putting your money in another product, such as a bonus savings account. Don’t forget, some bonus savings accounts pay as much interest as some term deposits, are also covered by the ADI government deposit guarantee, earn compounding interest and come with the added convenience of allowing fast easy access to your funds.

William Jolly is a finance journalist, formerly at Canstar and now at savings.com.au. Much of his work is centred on helping to improve the financial literacy of Australians and provide them with resources on how to save more money in their everyday lives.

Do you follow the trends in term deposits? Have you found better rates at the smaller institutions?

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Written by William Jolly

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