Term Deposits

Term Deposits 101

New to term deposits? Learn the basics so you can lock away your funds with confidence.

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.

How is interest on term deposits calculated?

How interest on a term deposit is calculated will depend on a few things, but mainly:

  • The size of your deposit
  • How long your term is
  • The interest payment frequency
  • Compounding

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.

Common term deposit fees

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 elapsedInterest 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.

What features do term deposits offer?

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.

Pros and cons of term deposits

To summarise all of the above info, here’s a table of the pros and cons of term deposits:

Pros
Cons
    They’re a safe and stable investment
  • Virtually no risk – you have a government guarantee of up to $250,000*
  • Fixed rates so you know exactly what your returns will be ahead of time
  • Your money is locked away, so there’s no temptation to spend it
  • Very few have upfront or ongoing fees
  • No effort to maintain – set and forget!
  • Interest rates are low at the moment – you’ll struggle to earn more than 3.00% p.a.
  • Fixed rates so your rate won’t rise if the cash rate rises
  • They’re not a flexible option and have very few features
  • Not being able to withdraw your money easily isn’t ideal at times when money is short
  • There are hefty interest rate reductions for early withdrawals
  • No topping up term deposits with extra cash

*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.

How to choose the right term deposit

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?

Frequently asked questions

1. What are the differences between a term deposit and a savings account?

A term deposit differs from a savings accounts in several aspects, including interest rates, fees, flexibility and features. The most important aspect to remember is interest rates. While savings account interest rates are variable and fall or rise at the bank’s discretion, term deposits have fixed rates so they don’t fluctuate. Read more on the differences between savings accounts and term deposits.

2. Do you pay tax on term deposit interest?

You generally have to declare investment income in your tax return, which includes interest earned on a term deposit. This interest is taxed at your marginal rate. Read more on inflation and tax on term deposit returns.

3. How long is a term deposit?

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 and five years. Read more on how the different term affect your returns.

3. How long is a term deposit?

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 and five years. Read more on how the different term affect your returns.

4. What happens when a term deposit matures?

At the term deposit’s maturity, if you want to keep your money in a term deposit, you might appreciate the convenience of an automatic rollover. Alternatively, you can either reinvest your money in a differen term deposit or close your account and have the money transferred to your nominated bank account.

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