Bank term deposits are a type of cash investment that is held in a bank account for an agreed time period (term).
Once you deposit your money, you typically aren’t able to withdraw it until the end of the term without being charged a fee.
Term deposits are a popular savings option because they allow you to lock in an interest rate before you make the deposit. This means you know how much you will earn in interest during the term, and you can have peace of mind that your money won’t lose value.
Pros and cons of bank term deposits
If you’re thinking about using a term deposit to grow your money, here are some of the pros and cons to consider:
- Safe investment – Your money earns interest at a fixed rate, so it isn’t exposed to downturns in the market
- Low maintenance – Once you make the deposit, you can leave it untouched until the term ends
- Enforced savings – Because you can’t access your money for the duration of the term without paying a fee, you may be less tempted to spend your savings
- Your money is locked away – You can’t withdraw your money during the lifetime of the term (unless you are willing to pay a penalty), which means it’s off-limits even if another investment opportunity arises
- Low returns – Although the interest rate is fixed, the earnings may be lower than other types of investments
- No bonus interest – Unlike some high-interest savings accounts, there’s no way to earn bonus interest on savings in a bank term deposit
How are bank term deposit interest rates calculated?
There are several factors that influence the interest rate you’ll earn on a term deposit.
Firstly, the Reserve Bank of Australia’s cash rate influences the interest rates that lenders charge for term deposits (as well as home loans, credit cards, and savings accounts). Typically, a low RBA cash rate means a low interest rate – which isn’t ideal for term deposits.
The term you select and the amount you deposit also affect the interest rates offered to you. Generally, the more money you invest and the longer you agree to keep it deposited, the higher the interest rate will be.
Features to consider when choosing a bank term deposit
When selecting a term deposit, it’s important to read the fine print so you know all the terms and conditions that come with the deposit. Some of the key features to look out for include:
There are two main types of term deposits – short-term and long-term. Short-term deposits are usually for a period of less than a year and as little as a month. If you have a short-term goal such as saving for a holiday, this type of term deposit could be a good option.
Long-term deposits are typically for saving over more than a year and up to five years (or even seven years in some cases). This type of term deposit could be suitable if you have a more significant savings goal or want to take advantage of a higher interest rate.
The interest rate you agree on at the start of the term will determine how much of a profit you make off your deposit, so it pays to do some research and look at all your options.
Keep in mind that the longer you keep your money in the bank and the more money you can deposit, the higher the interest rate will tend to be.
How often interest is calculated on bank term deposits
The return on your investment can differ significantly depending on whether interest is compounded or simple, and how often interest is accrued.
For example, if you invest $10,000 for five years at 5 per cent per year, with simple interest paid at the end of the term, you would earn $2,500 in interest ($500 each year), giving you a total balance of $12,500 at the end of the term.
If you invest $10,000 for five years at 5 per cent, with compound interest calculated and added annually, you would earn $2,763 in compound interest after five years, giving you a total of $12,763. The total returns are higher because interest is calculated and added to the balance of the deposit each year, rather than at the end of the term.
Penalty fees for bank term deposits
If you decide you want to cash out your bank term deposit before the end of the term, it’s likely you’ll be charged a penalty fee.
Some banks calculate this fee by deducting a percentage of your interest rate. Others may charge you a flat fee based on factors such as current market interest rates, your interest rate, and your term deposit balance.
Make sure you’re aware of how penalty fees are charged by your bank and the conditions for withdrawing money before the deposit reaches maturity.
Most banks offer term deposits, but they may differ in interest rate, terms and features, so it’s worth comparing term deposits at RateCity to find one that suits your requirements.