What is a term deposit?
Term deposits (also known as TDs) are a basic low-risk investment product. With a term deposit, you deposit a lump sum of money in a financial institution for a set term in exchange for a fixed rate of interest. When the term is over, you receive the interest on the amount you deposited.
Different term deposits can have fixed terms between one month and five years. The end of the term is known as ‘maturity’.
Term deposits are popular among risk-averse investors who want a near-guaranteed return on their investment.
Who offers term deposits?
Only Authorised Deposit-taking Institutions (ADI) can offer term deposits in Australia. These include banks, credit unions and building societies. You can view a list of Australian ADIs on APRA’s website here.
Government guarantee on deposits
The Australian Government guarantees deposits up to $250,000 with ADIs. This means if your bank (an ADI) were to collapse, you can recover up to $250,000 of your deposited money (e.g. money in term deposits, savings accounts, home loan offset accounts etc.) with that bank from the government. This applies per person and per ADI, so you can have multiple guarantees with different ADIs, but only one with the same ADI.
Between October 2008 and February 2012, the guarantee covered deposits up to $1,000,000 as a temporary measure to help guide Australia’s banking sector through the Global Financial Crisis.
Because of the government guarantee, term deposits are generally considered to be a very low-risk investment, albeit with low returns.
Term deposits earn very similar interest rates to savings accounts and are heavily tied to the cash rate – we’ve written a more detailed article on the interest rates of each here. Given Australia’s record-low cash rate of 1.50%, you’ll struggle to find a term deposit paying over 3.00% p.a. According to the RBA’s Retail Deposit and Investment Rates data, the average interest rates from Australia’s five largest banks at the time of writing (December 2018) are:
- One month: 1.40% p.a.
- Three months: 2.90% p.a.
- Six months: 2.00% p.a.
- One year: 2.20% p.a.
- Three years: 2.45% p.a.
Term deposit interest rates are fixed, but as you can see here, they tend to vary depending on the term you choose (that’s how long you deposit your money for). Term deposits with longer terms tend to have higher interest rates than ones with shorter terms (to encourage customers to lock their money away for longer periods of time so the bank can use this money for funding), although as you can see by the average three-month term deposit rate, this isn’t always the case.
Some institutions are more competitive than others when it comes to term deposit interest rates, so you can get rates higher than 3.00% p.a. if you shop around.
How is interest on term deposits calculated?
How interest is calculated will depend on a few things, but mainly:
- The size of your deposit
- How long your term is
- The interest payment frequency
We said before that longer-term deposits are more likely to pay higher interest rates. This is mostly true, but the frequency of repayments can lead to varying interest rates on the same term.
For example, one provider might offer an interest rate of 2.60% p.a. on a three-year term deposit that pays interest in a lump sum at maturity. Investing $50,000 into this would fetch you $4,200 in interest after three years, because it’s calculated using simple interest.
But the same provider might offer 2.55% p.a. on a three-year term deposit that pays interest monthly, earning a total of $3,825 in interest over the three years. Generally, term deposits with more frequent interest repayments have lower interest rates than those that pay interest at maturity.
Most term deposits don’t offer compounding interest, but at the time of writing (January 2018) there are a small number of term deposit products that do, particularly on terms of over 12 months. Of these, interest can be compounded annually, semi-annually, quarterly or monthly. A term deposit product that offers compounding interest will earn more than a term deposit with the same rate that doesn’t.
For example, investing $50,000 into a 3.00% p.a. annual compounding 3-year term deposit will earn you $4,305 at maturity, while putting the same amount into a non-compounding 3-year term deposit paying the same rate will earn you $4,179, which is $126 less.
The majority of term deposits products are fee-free – you’d be hard pressed to find any that charge monthly account-keeping fees or introductory fees like other products. You’ll find most term deposits do charge a fee or a penalty for early withdrawals though. This can either be a flat fee or a tiered ‘interest rate reduction’ that lowers your fixed rate depending on how long you have left in your term.
This fee or reduction will vary between providers, but a common way they reduce your rate is as follows:
|Percentage of the term elapsed||Interest rate reduction|
|0% to 20%||90%|
|20% to 40%||80%|
|40% to 60%||60%|
|60% to 80%||40%|
|80% to 100%||20%|
This can be bigger than any savings account fee if you end up losing large amounts of interest. Banks don’t want you to withdraw this money, and may also ask that you provide them with up to 31 days notice before you withdraw.
Term deposits are very basic investment products, so you aren’t likely to find one stuffed with advanced features. The main things to look at is the interest rate and the term you want to invest for. A good term deposit product should offer a variety of terms with different interest rates for you to choose from.
That being said, there are a couple of other factors to consider when choosing a term deposit:
- Is it easy to set up?: More and more banks are starting to offer term deposits through online and mobile banking – can you easily log in, open a term deposit and view your balance online?
- Automatic rollover: At maturity, certain providers will automatically ‘rollover’ your term deposit into a new one unless you expressly tell them otherwise. Remember that term deposits are difficult to withdraw from during the term, so you might not want a term deposit that does this. Make sure you read your product’s terms and conditions before opening and keep track of the end date to let your bank know you want to withdraw.
Term deposits that rollover might also receive a lower interest rate.
Opening a term deposit can be a straightforward process. You’ll just need to provide:
- Your personal details (name, address, phone number)
- Proof of ID (driver’s license, Medicare card)
- Tax file number
- A nominated bank account for your funds to be deposited into at maturity
You will need to nominate with your bank what term you want to invest for, and the corresponding interest rate. Be aware that some term deposits require a minimum investment too. The minimum is usually around $500-$1,000 but can be in excess of $100,000 for some certain term deposit products.
To actually open the term deposit, you can either do it online or by visiting a local branch. Some institutions might require you to be an existing customer to open a term deposit online.
To summarise all of the above info, here’s a table of the pros and cons of term deposits:
If you do decide to go with a term deposit, then you should look to consider everything we’ve discussed above:
- What are you investing for?
- How long do you want to invest for? Compare the terms.
- What interest rate do you want?
- Will you need to withdraw the money at any time? Look at the fees and penalties.
- Do you want the interest paid at maturity or on a regular basis (e.g monthly, quarterly)?
- Are there any products offering compound interest?
- Can you apply for and close the term deposit online?
- Will it automatically rollover at maturity? Are you ok with this happening?